Saturday, October 31, 2015
When Candy Isn’t Candy
Now we learn that the issue I noted in Halloween and Tax: Scared Yet? (2005), the different sales tax treatment in some states between candies made with flour and those that are not, has caught the eye of the consumer. Flour is used in candies such as licorice, KitKats, and Nestle’s Crunch. In a Napa Valley Register commentary, Jill Cataldo describes the bewilderment faced by her sister when her sister noticed that the sales tax on Twix bars was much lower than the sales tax on Snickers purchased for the same cost. Cataldo did some research and discovered what I had described ten years ago, that in her sister’s state and in many others, the presence of flour in an edible item causes the item to be classified as “not candy” and thus subject either to a lower sales tax or no sales tax. So, as she points out, chocolate covered cherries are candy and thus receive less favorable sales tax treatment. Chocolate covered pretzels are treated as “food” and either escape sales tax or are taxed at a more favorable rate.
Cataldo made the point that consumers looking to save a few pennies on Halloween candy purchases should look for those items that contain flour. I wonder how many people can make a list, without looking it up, of so-called candy that is treated as food under sales tax laws because they contain flour. However many people can do so, I’m confident that the number of people who can explain why this difference exists is far fewer. I can guess, but it really makes no sense to conclude that the inclusion of flour makes the item sufficiently nutritious to deserve more favorable sales tax treatment.
The most important question, though, is how many people are going to hand out Kit Kat bars or Nestle’s Crunch and tell the children, “This really isn’t candy.” My guess, and hope, is zero, because I can’t imagine anyone wants the youngsters running through the neighborhood shouting, “Those people gave us something that they said isn’t candy,” or, worse, “Those people have problems, because they gave us candy and said it wasn’t candy.” I prefer to have a repeat of what the children exclaim when they leave my front door, “He’d giving out Reese’s Peanut Butter Cups.” Indeed. Truly nutritious food. How scary is that notion? Happy Halloween.
Friday, October 30, 2015
Where Do the Poor and Middle Class Line Up for This Tax Break Parade?
Where is the parade? The one that has my attention is in New Jersey, but there are similar parades all over the nation. The New Jersey parade gives away tax dollars to prosperous corporations. Why? Because those corporations threaten to leave New Jersey or to refrain from coming to New Jersey even though at least some of them don’t have much of a choice. Here are some of the featured participants:
- The Philadelphia 76ers, as described in In When the Poor Need Help, Give Tax Dollars to the Rich.
- Lockheed Martin, as described in Fighting Over Pie or Baking Pie?.
- Subaru, as described in Why Do Those Who Dislike Government Spending Continue to Support Government Spenders?.
- Berry & Homer, as described in When Those Who Hate Takers Take Tax Revenue
One of the arguments put forth by the anti-government-spending folks is that it is bad morally, socially, and politically to collect taxes from one group and to disburse the receipts to another group. These folks like to brand the first group as “makers” and the second group as “takers.” Yet when the takers are their friends and allies in the movement to feudalize America, not a peep is heard from them.Previously, in Why Do Those Who Dislike Government Spending Continue to Support Government Spenders? I had written:
New Jersey, governed by a member of the political party that is trying to consolidate its power by demonizing “takers,” provides an excellent example of the hypocrisy entrenched in this modern reverse Robin Hood philosophy. * * *
Though this tax revenue giveaway game has been underway for several years, there is no sign that the economic condition of Camden’s residents have improved. The folks in Trenton who rail against government spending cut education spending, job training spending, social welfare assistance, and a variety of other expenditures denounced as enabling “takers” to feed at the public trough. Yet in the meantime, a state that faces deficits in its transportation infrastructure budget continues to funnel taxpayer dollars into the hands of companies with sufficient political connections to snag some funds for themselves. * * *
At what point will enough voters see through the con game and send packing the takers who took over political control by demonizing takers? When will political hypocrisy disappear? At what point will people realize that economic growth consists of creating something of economic value and not simply moving jobs from one place to another?
There’s something not quite right in the collective psyche of the anti-government-spending crowd. Enraged by high taxes, they manage to put into office, and keep in office, people who dish out tax revenues as though there were no limits on taxation. Of course, the tax breaks go to those who are in least need of economic assistance. Their excuse, that they will use the tax breaks to help those in need, is hilarious, because the best way to help those in need is to direct assistance directly to them so that they can infuse those dollars into the economy. That makes the economy grow. Handing tax dollars to those who don’t need financial assistance is nothing more than helping some people grow their Swiss bank stash.These words have not reached the eyes of those lining up their corporate friends for parade entry, and in the off chance they are aware of the criticism, from myself and others, they are overwhelmed by the focus on monetized power politics.
So could it be time for “if you can’t beat them, join them”? Not for those of us who lack the resources to sign up for the parade, or perhaps what should be called the corporate gravy train. That is the essence of what is wrong with this nation’s economic condition. Those with more than sufficient money can afford to get more money, and those with insufficient funds are too poor to get more money from the legislative handout machine. Eventually they will have everything and the rest of us will have nothing. By then, it will be too late. The parade will be over, and almost all of us will have been left out.
Wednesday, October 28, 2015
God’s Blessing Can’t Save Prohibited Deductions
In a recent case, Canna Care, Inc. v. Comr., T.C. Memo 2015-206, the Tax Court rejected the taxpayer’s claim that it was not engaged in a trade or business because California law prohibits the distribution of marijuana for profit and the parties stipulated that the taxpayer was not operated for profit. The Tax Court explained that the fact the taxpayer was operated in accordance with California’s restriction on profiting from distributing marijuana did not affect its finding that the taxpayer was engaged in the business of distributing marijuana for purposes of section 280E. The court noted that the salaries paid to the taxpayer’s owners were “well in excess” of those paid to its other employees, an indication that the taxpayer had been formed to generate income.
According to the court’s recitation of the facts, the taxpayer was owned by a married couple who had six children and were facing financial hardship compounded by increased tuition expenses for those children. The husband “turned to his faith for a solution. After much prayer, [he] was convinced that God wanted him to open a medical marijuana dispensary to solve his family’s financial woes.” Because the husband’s prayer was motivated by a desire “to cure his family’s financial difficulties,” the claimed divine inspiration did not absolve the taxpayer of the restriction imposed by section 280E.
Monday, October 26, 2015
What Tax Cuts Have Done
Now that the tax-haters have control of Congress and most state legislatures, their need to be deceptive has diminished. Because of gerrymandering, even if the majority of Americans voted in favor of undoing the damage, it would have no effect. Controlling the White House or a governor’s house means little when legislatures – such as the Congress and the crew in Harrisburg, Pennsylvania – refuse to act unless the elite who control them get their way.
And it is in that setting billionaire Carl Icahn has threatened the Congress with his money. He has set up a $150 million political action committee, and if the Congress does not enact more corporate tax breaks he will use that money to re-constitute the membership of Congress to a group that does what he wants. Specifically, Icahn wants American corporations that made money but avoided paying taxes by shifting the profits overseas to be permitted to bring that money back to this country without paying the taxes that otherwise would apply. One of the companies that has engaged in this scheme is Apple, in which Icahn is one of the largest investors. Apple has stashed $181 billion overseas, more than any other American corporation.
The president of Every Voice Center, an advocate of campaign finance reform, points out that Icahn’s threat demonstrates “what politics has come to be, which is an argument among billionaires.” In other words, if you’re part of the 99 percent that cannot afford to purchase or threaten Congress, you don’t count. That is, I suppose, what democracy means to the oligarchs. Democracy for them, not for anyone else. So billionaires like Icahn, the Koch brothers, Tom Steyer, and Sheldon Adelson call the shots and use their money to dictate public policy, one pillar of which is to attack the rest of the nation’s citizens by crushing them economically, cutting their benefits, reducing their work hours, curtailing their voting rights, and letting public infrastructure rot away. So now we know what the tax cut beneficiaries have been doing with their tax cuts.
Back in 2004, a similar provision was enacted that permitted corporations to repatriate their overseas profits. It was advertised as a job-creating no-brainer. According to a Senate study seven years later, the provision did not create jobs. Instead, corporations stashed more profits overseas, and, of course, the economy fell apart a few years after the 2004 provision was enacted. But, as has been the case with every other failed economic ploy enacted or proposed by the anti-tax lobby, the failed provision is offered up again and again. Clearly, the ability to learn from one’s mistakes is not a skill possessed by these folks. Icahn’s announcement pretty much underscores his intention to use his wealth to mis-educate the public by saturating the airwaves and internet with more false claims about the job-creating benefits of creating even more tax breaks for the people least in need of tax breaks or any other sort of economic relief.
For whatever flaws there are in government, there is an even bigger flaw in letting oligarchs run the country. There is no voting booth or polling place to which one can go to vote out the oligarchs. The window for fixing the problem is closing quickly.
Friday, October 23, 2015
A Hidden Tax Twist?
The reader suggested there might be adverse tax complications. The columnist stated that paying off the mortgage on the existing home would have no tax effect. At first glance, it appears that the reader is doing nothing more than lending money to the mother. Similarly, lending the money to the mother so that the mortgage on the new home is lower would appear to be nothing more than a loan. Generally, the making of a loan does not trigger income tax consequences because the lender is replacing one asset, cash, with another, loan receivable, and thus is not economically wealthier or poorer, and because the borrower is adding an asset while also adding an offsetting liability, and thus also is not economically wealthier or poorer.
However, neither the reader nor the columnist asked about, or mentioned, whether the reader would be charging interest on the loan to the mother. If interest is not charged, or is charged at a rate lower than the applicable rate, section 7872 would come into play. The amount of foregone interest would be treated as a gift from the reader to the mother, with these consequences. The reader would be treated as making a gift for gift tax purposes in the amount of the foregone interest, and would be treated as having interest income in that amount for income tax purposes. The mother would be treated as receiving a gift, excluded from gross income, in the amount of the foregone interest, and would have a potential mortgage interest deduction in that amount. Because the loan in question does not exceed $100,000, the amount of foregone interest for income tax purposes would be limited to the amount of the mother’s net investment income, or zero if the net investment income is $1,000 or less.
It is likely, though not certain, that the mother’s net investment income is zero or very low. But it is possible that the mother has net investment income from assets that cannot be liquidated to provide funds for paying off the existing mortgage or applying to the cost of the new home. Though some might consider this question to be “theoretical,” it isn’t. It isn’t theoretical until and unless all of the necessary facts are known. The fact that it might turn out that the mother’s net investment income is $1,000 or less does not mean that it should be presumed to be so.
The reader’s question would find its way onto a basic federal income tax examination if I were still teaching that course. It provides an opportunity to identify students who understand the tax issues at a basic level, that is, those who earn points for describing the income tax consequences of paying off a loan or making a loan. And it would also provide an opportunity to identify students who would earn even more points for identifying the section 7872 trap that lurks in the background. It is the sort of question that could be asked in terms of “what additional facts do you need to know?” Many students don’t like those types of questions, being accustomed to the “tell me the facts and I will tell you the answer” approach, but in practice, as the reader’s question suggests, the clients usually don’t present all the facts, often do not know what facts they need to be presenting, and need the attorney or accountant to help them identify relevant information.
Wednesday, October 21, 2015
Beachfront House Rental Deduction Washed Out
On its federal income tax return for its taxable year ending February 28, 2009, the taxpayer claimed an advertising deduction that included, among other things, expenses related to the wedding. On its general ledger, under advertising and promotion, the rental amount of $22,950 was listed as “PRUDENTIAL PROP RENTAL.” The IRS disallowed the entire advertising expense deduction.
The taxpayer argued that the $22,950 was deductible because it was for a “corporate retreat” held at the beachfront house, claiming that “the retreat served a legitimate business purpose by enhancing employer-employee relationships for future productivity and preserving and expanding” the taxpayer’s relationship with its primary client. The Tax Court determined that the entry in the general ledger, the lease, and the credit card authorization did not establish that the $22,950 was paid. William B. Karras testified that he was present at the beachfront house, that it was rented to hold the taxpayer’s weeklong company meeting followed by entertainment and that “just the vendors and the subcontractors * * * were invited, along with our employees.” He also testified that his fiance, some of her family, and a few of his friends showed up because “we ended up sponsoring a – hosting a fishing trip shortly after as well.” Though unsure of the number of employees who attended – between 5 and 10 – he testified that more than 30 people were at the meeting. He affirmed that his wedding was the day after the meeting ended. The Tax Court noted that the taxpayer had stipulated that the advertising expense deduction included payments made for the personal expenses of the wedding, but that William B. Karras did not clarify what part of the rent was not related to the wedding expenses.
The Tax Court concluded that the testimony of William B. Karras was vague, uncorroborated, and led by the taxpayer’s attorney. Thus, the expenses were not substantiated and the deduction was disallowed.
Was this simply a case of a taxpayer who neglected to substantiate a deduction by not hanging onto receipts that proved payment? Was this a case of a taxpayer whose shareholder was unable to remember facts that supported the deduction? Why were 20 to 25 people who were not employees at a corporate retreat designed to encourage employer-employee productivity? Why was the retreat during a holiday week? Why was it at a beach? Why was it just before the wedding of one of the shareholders? The Tax Court found a way to resolve the case without getting into these questions. How nice for the taxpayer. But, by the way, the Tax Court upheld section 6662 penalties against the taxpayer. That was not a surprise.
Monday, October 19, 2015
Will Taxpayers Sleep Well When They Read This Report?
As a result, the IRS does not have the latest ability to combat data breaches and remains at risk of hacking attempts and data loss or corruption due to malware. When the IRS’s data and network are not secured, taxpayer information becomes vulnerable to unauthorized disclosure, which can lead to identity theft. Further, security breaches can cause network disruptions and prevent the IRS from performing vital taxpayer services, such as processing tax returns, issuing refunds, and answering taxpayer inquiries. . . . We believe that running workstations with outdated operating systems pose significant security risks to the IRS network and data, particularly in the environment where a chain is only as strong as its weakest link. External hackers or malicious insiders need to locate only the one computer with security weaknesses, such as one with an outdated operating system, to exploit in order to steal data or further compromise other computers.The report reveals that IRS management of the operating system replacement left much to be desired. Certain procedures were bypassed, and somehow there are more than a thousand computers that cannot be located.
Before casting full blame on the IRS, it is important to consider another finding by TIGTA: “In addition, budgetary constraints at the start of the Windows XP upgrade effort on April 2011 forced the IRS to upgrade old computers rather than purchase new computers, which would have made the upgrade process easier due to the compatibility of new hardware with new operating systems.” In other words, Congress made the task more difficult. Ultimately, responsibility for the IRS rests with the Congress, because it is an agency to which it has delegated particular tasks. Failure of the Congress to provide the IRS with the necessary resources and appropriate supervision is yet another indictment of the degradation of the American legislative process, particularly at the federal level.
Though it is tempting to some to use this news as another reason to criticize, attack, and shrink government, keep in mind that it is worse in the private sector. At least with the IRS, there is an audit and report. Has the public been the beneficiary of any such audit or report with respect to the thousands of private companies that acquire and retain sensitive customer and client information? As horrible as it is to have one’s tax and related financial information compromised, for many people it is worse when their health information or personal behavior is revealed without their consent. The underlying problem is much deeper, and involves an amalgamation of evil behavior with inadequate education and management. The solution will not be easy, but if one is not found, life for many people is going to become far more than inconvenience caused by delays.
Friday, October 16, 2015
Taxes, Consumption, Soda, and Obesity
Now comes a report that the enactment in Mexico of a soda tax that meets the demands of the soda tax advocates did cause a reduction in the consumption of soda, particularly among lower income individuals. This resolves the argument between those who claim a soda tax would reduce soda intake and the soda industry which claims that soda taxes would not deter soda consumption. I’ve never thought this issue deserved attention, because it doesn’t require rocket science or an experiment in Mexico to figure out that an increase in a tax on an item will reduce consumption of that item unless the item is an absolute necessity or unless the black market finds a way to provide the item while evading the tax.
What remains undetermined is whether a reduction in soda consumption will reduce obesity and other adverse health effects. It will take many years to figure this out. It will not be easy. Why? Because there are multiple variables in the causation of obesity and other adverse health effects. It is not unlikely that people who find soda to be too expensive because of the tax will spend their dollars on pies, cakes, candy, doughnuts, cookies, ice cream, and similar items. Because it is absurd to think that taxing soda consumption out of existence will cause significant decreases in obesity and other adverse health effects, any tax attack on bad health habits would need to be far-reaching. And, of course, making a tax attack that far-reaching would be counterproductive in many ways, and poses all sorts of policy concerns. Though advocates of the soda tax point to tobacco taxes as the reason for reduction in the use of certain tobacco products, it is far more likely that the “shock and horror” public service messages and advertisements, or the experience of watching someone die from tobacco-induced cancer, has a much stronger effect on behavior.
Wednesday, October 14, 2015
Taxes, Benefits, Freedom, and Greed
Dennis S also notes a behavioral pattern that isn’t new and hasn’t gone unnoticed over the past decade. When New Jersey and other Mid-Atlantic states requested federal aid to help rebuild communities devastated by Hurricane Sandy, anti-government, anti-tax legislators opposed spending the money. The entire South Carolina Congressional delegation voted against the aid bill. Now that South Carolina needs assistance, these anti-government, anti-tax advocates are demanding federal aid. The state that has collected the most federal emergency funding since 2009, Texas, is represented in Congress by a Senator who rails against pretty much every federal program. He relents, of course, when his state stands to rake in money paid by taxpayers in other states.
Then I picked up on a Glenn Reynolds USA Today commentary, in which he frets that Americans are moving from blue states to red states. Reynolds suggests that “people who earn enough money to pay taxes” are trying to escape the high taxes of blue states, whereas those “living on welfare benefits and [not] plan[ning] to change that” would not move to a low-tax state to escape taxes and, if they were to move at all, would select a blue state offering higher welfare payouts. Reynolds explains that the high-tax states eventually will end up with more people who live off benefits, and fewer taxpayers, whereas the low-tax states eventually will end up with fewer people who live off benefits, and enough growth in taxpayers that would permit more tax reductions. The high-tax states, he claims, will go bankrupt. He then notes two possible counter-trends. One, that the high-tax, high-benefit states might lower taxes and reduce benefits, though he considers this unlikely. The other, that taxpayers moving from high-tax states to low-tax states “might bring their political attitudes with them, . . . supporting the same policies that ruined the states they let.” Reynolds offers advice to “conservative billionaires,” suggesting that they pay for programs that explain to blue state residents moving to red states that they should change the way they vote. He admits he does not know if this would work.
As I read this, I kept in mind that South Carolina is a red state. I wonder what is going through the minds of people who moved to South Carolina in order to benefit from lower taxes by cutting benefits. Intact bridges, sturdy dams, functioning electrical power grids, drinkable tap water, and protection against death surely are benefits. I wonder how many South Carolinians, native or newly arrived, are wondering about the “cut taxes, cut benefits” mantra financed by those who need tax cuts simply to finance their purchase of, and subsequent tear-down, of governments. When they succeed – I fear it is not a question of if they succeed – those same benefits will be available to those capable of paying the private sector price, which I guarantee will make the tax cost of these societal needs pale in comparison. What, then, becomes of freedom? Freedom from abusive private sector behavior is no less important than freedom from abusive government. One does not attain that freedom by destroying the private sector or by destroying government. Freedom is attained by destroying greed.
Monday, October 12, 2015
A Federal Income Tax on Everybody? How Would That Work?
So, Mr. Jindal, does that mean the person with no income would be required to pay an income tax? How about infants who are not trust fund babies? Would they be paying an income tax? Are you serious?
Jindal’s prize-winning absurdities include elimination of the standard deduction, the deduction for personal and dependency exemptions, and most other deductions. The federal income tax liabilities of almost all lower-income and middle-income Americans would increase.
And what would Mr. Jindal do with the increased revenue? Would he reduce the budget deficit? No. Would he see to it that the nation’s infrastructure is spared becoming a competitor for worst in the world? No. He would eliminate corporate income taxes. And the federal estate tax. Anyone with even half a brain knows who would be stashing even more cash with those moves.
Jindal also proposes a credit for people with children under 18, though it is unclear whether this would be for all families or just those with small amounts of income. He proposes a similar credit for people older than 65 whose income is under $5,000. Imagine scraping by on $5,500 of annual income and being required to pay into an income tax system originally designed to reduce the income and wealth inequality of the late nineteenth century, which had plunged the nation into economic crisis time and again.
So after Jindal claims every American should be paying federal income tax, he proposes a plan that doesn’t accomplish that result. Brilliant. When he adds in the claim that by reducing federal tax revenue – which must mean huge reductions for the economic elite, because surely the 99 percent not in the top one percent would not be getting reductions – wages would grow at more than 8 percent, he demonstrates why he ought to be sitting in some tax classes. Again, anyone with half a brain knows what happened when a similar “cut taxes on the wealthy” stunt was pulled early in this century. There’s more to responsible tax policy than dishing out sound bites that play to the peanut gallery. There’s a reason I don’t blog about quilting, needlepoint, and welding.
Fortunately, there is very little chance that Mr. Jindal will be moving from Baton Rouge to 1600 Pennsylvania Avenue. Hopefully, no one else will take ownership of his daft tax ideas.
Friday, October 09, 2015
A Crappy Tax Idea?
The title of the article, How One Man Wanted To Save The World By Taxing Its Poop is misleading. The one man in question, Pierre Leroux, proposed something rather different. He came up with his idea by combining his goal of letting “a country maintain its citizenry without exerting authority over them, and for people to retain their property without using it to deprive others” with his Malthusian beliefs that scarcity drives desperation and authoritarianism and his theory that human feces could be used to fertilize crops in the same way animal manure was used.
So Leroux, also critical of the then-current practice of piping human waste into the countryside where it was released without regard to its impact, proposed that human waste would be collected and used as fertilizer. But he did not propose a tax on human poop. Instead, under his plan, each person “would religiously gather his dung to give to the State, that is to say the tax collector, in place of tax or personal levy.” In other words, Leroux was suggesting that taxes be paid, not with money, but with human waste. Not surprisingly, his idea tanked.
In Les Miserables, Victor Hugo picked up on the idea, describing sewers as “gold flowing from full hands.” Perhaps it is fortunate that Hugo’s defense of Leroux’s theory did not find its way into the musical. Imagine the inspiration it would give to the folks who express their displeasure with tax policy by paying, or attempting to pay, tax liabilities with pennies, as I described in Does It Make Tax Cents?. Though I described “the use of pennies and coins [to pay taxes as] an event which happens often enough to be almost boring,” I guarantee that if a news report comes along describing someone’s attempt to put the Leroux tax payment proposal into action, I will write about it. That sort of stunt surely would bowl over the tax collector.
Wednesday, October 07, 2015
Putting More Tax Information “Out There” for the Tax Database Thieves
Thomas proposes reducing the efforts needed to comply with the tax law. She offers several ideas. One is to permit taxpayers to use electronic devices such as smart phones to input their tax-relevant transactions into an online database that could then be ported over to an electronic tax return. Another is to increase the number of transactions subject to third-party information reporting, with the data finding its way into the online databases described in her first idea. Yet another is a modified version of ReadyReturn, in which the taxpayer, rather than the Internal Revenue Service, prepares the return using the information in the online database.
Thomas recognizes that her ideas might encounter several objections. They might cost more than the benefits they provide. They might be unnecessary considering that professional return preparers and tax preparation software already exists. They might diminish taxpayers’ understanding of the tax laws. In a footnote, she acknowledges the concern that I have, and that is security. She writes, “One important concern here would be security.” She notes that there have been problems with national-security surveillance, with the Affordable Care Act web site, and with hacking of government databases. Her response is two-fold. One is that because private companies also have been hacked, government online database security is not necessarily inferior. The other is that taxpayers could be made more comfortable with the process by enrolling participants one small group at a time.
Thomas describes an abandoned IRS project called “My IRS Account.” The plan was to take existing portals and combine them so that taxpayers could access their tax information directly. The officials who cancelled the project explained that inadequate funding and the lack of an acceptable business strategy doomed their efforts. The Electronic Tax Administration Advisory Committee has recommended reviving the project, claiming that the IRS should follow in the footsteps of banks and retailers who have similar systems in place. Thomas writes, “Providing numerous taxpayer services in one place would greatly simplify taxpaying.”
Though there is much convenience in having everything in one place, as Thomas suggests, there is another side of “one place” that looms large, and that is “single point of failure.” If hackers find their way into a taxpayer’s account, everything is at risk. There is a reason people are advised not to invest all of their savings in one stock. Diversification reduces risk. And the risk faced by taxpayers in 2015 is that the IRS has an abysmal track record when it comes to data security. Identity thieves file returns in the names of people who then cannot file their returns and are trapped for months and years trying to straighten out the mess. Crooks file false returns that generate billions of undeserved refunds. The transcript database was compromised. The fact that the private sector is almost as derelict in its obligation to keep information secure is no excuse, nor should the private sector be held up as an example to be followed.
Until and unless the protection of online data is heightened to a point of 99 percent confidence, the IRS should not create yet another vulnerability, another door through which the robbers can force their way in. In the meantime, why not focus on the problem rather than the symptoms? The underlying cause of some noncompliance is the complexity of the tax laws. Treating the symptoms does not cure the illness. The tax laws need to be simplified, though that will not reduce noncompliance on the part of those for whom complexity is not the issue.
It will take money to strengthen the security of online government databases. It will take political courage to simplify the tax laws. Both are tasks that are within the scope of the responsibilities set in front of the Congress. Until and unless the Congress acts responsibly with respect to these responsibilities, creating another online tax information database will energize the thieves and hackers who thrive on the opportunity to attack weaknesses such as single points of failure.
Monday, October 05, 2015
Analyzing Income Inequality
According to Zucman, all of the financial liabilities in the world should equal all of the world’s financial assets. That’s because each financial instrument represents, ultimately, a lender and a borrower. One example is the issuance of a bond by a corporation. The corporation has a liability, and the purchaser of the bond has a matching asset. Similarly, a person who puts $500 in the bank has an asset worth $500, and the bank has a liability of $500 because it owes $500 to the owner of the bank account. On a personal level, if someone lends $100 to a friend, the lender has an asset worth $100, which can be called a loan receivable, and the friend has a liability, or debt, of $100.
Yet the world’s accounts don’t balance. When the world’s financial assets and liabilities are added up, the liabilities are at least $8 trillion higher than the assets. As Zucman puts it, it’s as though planet Earth is $8 trillion in debt to the planet Mars.
So what’s happening? At least $8 trillion in financial assets have been hidden. Zucman thinks the amount is much higher, because the financial asset accounting does not include physical assets such as “houses, commercial buildings, land, art, yachts, gold, jewelry, and so on” that are held, for example, in offshore trusts. One can quibble about the number, but the point is that financial assets have been hidden.
So what’s the big deal about hiding financial assets? It means that they escape taxation. They escape property taxation that otherwise applies in certain jurisdictions. The income that they produce goes unreported, and is not taxed. And who benefits from this tax evasion? Those who can afford to engage in tax evasion strategies. In other words, those who already have significant wealth and income can increase their net worth even more, by reducing or eliminating the payment of taxes. In turn, this exacerbates income and wealth inequality. It also weakens the argument that the wealthy have earned their assets by engaging in economically beneficial behavior. Asset-hiding causes the truly small business, individuals of modest means, and the poor to be hit with the burden of taking up the slack. It certainly puts “maker” and “taker” in a very different light than the one used by the apologists for the greedy.
Zucman explains how this hiding game will make inequality even worse: “It’s not intuitive,[but] the impact on inequality is very big and could be even bigger down the road. The effective tax rate on wealth and capital is a key determinant of wealth inequality in the long run.” In other words, capital gets a higher rate of return than does labor, which causes increasing amounts of property to be owned by the very wealthy.
Zucman thinks a global financial register could increase compliance and deter law-breaking tax havens from continuing to assist in the destruction of the economies of nations whose tax revenues have been jeopardized by asset hiding. But I wonder if such a solution would work, as the isolationists in each country would object to the supposed erosion of freedom and liberty that they think comes from international cooperation. Unfortunately, these folks have no clue that their freedoms and liberties are being eroded even as I write, by asset-hiding tactics and the ever-growing shadow of income and wealth inequality. As Sun Tzu advised, know your enemy.
Friday, October 02, 2015
Taxation of Prizes, Question Three
Since the prize values are reported as other income I assume the tax rate would be whatever tax bracket you are in and not just the local/state sales tax?The tax rate that applies would be roughly the person’s tax bracket, though the impact depends on the numbers, as I like to say. Including the value of the prize in gross income affects adjusted gross income, which in turn can affect other items of gross income and deductions. For example, as adjusted gross income increases, certain deduction limitations increase, for some taxpayers. The same is true with respect to the amount of social security payments included in gross income, for some taxpayers. But as a rough rule of thumb, yes, if a person is in a particular tax bracket, that percentage can be used to come up with a rough idea of the tax impact.
The question, however, also referred to the local or state sales tax. The awarding of a prize is not a sale, so the sales tax ought not apply. But perhaps I am wrong. Are there any states in which a sales tax is imposed on prizes even though there is no sale? If so, that would have no effect on estimating the federal income tax liability generated by receipt of the prize.
Perhaps the person intended to refer to state and local income taxes. Most state income taxes apply to prizes, whereas local income taxes apply if they are broader, for example, than a simple earned income tax. And, yes, one can use the winner’s state income tax bracket percentage in computing a rough estimate of the state income tax liability generated by the prize.
Wednesday, September 30, 2015
Taxation of Prizes, Question Two
I won concert VIP tickets, there is no value on the tickets, so I can’t sell them. If no value is on them, why am I paying taxes on them? With W-1099I’m not sure what “With W-1099” means, though I suspect it means the person received a Form 1099. Some prizes are transferable, and some are not. That affects value but it does not cause the value of the prize to be excluded from gross income. What this person faces is a valuation problem. The fact that no price is printed on the ticket does not mean that the tickets have no value. Many things of value do not have prices on them or even attached to them. The company issuing the prize tickets presumably issued a Form 1099, and presumably there is a value on that form. So the answer is, the tickets have a value, that value was determined and placed on the Form 1099, and that amount must be reported as gross income.
I wonder what happened in this case. Did the winner report gross income equal to the amount on the Form 1099? Did the IRS show up? Unless the person who posted this question lets us know, the answers will remain a mystery.
Monday, September 28, 2015
Taxation of Prizes, Question One
Hi I have won a travel sweeps worth (ARV) $26,000. And after reading many articles about paying taxes and all, I told the sponsors I had to decline from the grand prize. She wrote back saying that their CPA said I don’t have to claim anything and they would not send a 1099 to us, since everything is paid for and there is no cash prizes. Is that legit?? Thanks for any advice and your reply.So a person wins a prize, tells the company awarding it that the winner cannot accept it because it will be taxed, creating a liquidity problem, and the company spokesperson says, in effect, “Not a problem, it’s not in cash, we won’t send a Form 1099.” So the winner asks, quite understandably, “Is that legit?”
I should leave this as an examination or semester exercise question, except that I no longer teach the basic federal income tax course. So here’s the answer, in a word. No. Does that come as a shock to my students who think that every answer is, “It depends”? I hope not. Sometimes the answer is a flat-out yes or no. But the tax professionals rarely are paid to answer those easy ones.
I wonder what happened in this case. Did the winner accept the prize? Did the company issue the Form 1099? Did the winner report gross income? Did the IRS show up? I’d say “stay tuned,” even though that phrase is fading out of use, but I can’t because I have no idea. Does anyone?
Friday, September 25, 2015
In What Year Should a Prize Be Reported as Gross Income?
The answer isn’t simple, though some try to avoid the complications. For example, the commentator at this site says “You only have to claim a trip prize on taxes AFTER you have taken the trip. When we won the France trip back in 2001 we didn’t actually take the trip until 2002 so we claimed it on our taxes in April 2003. That sure helps.” And the commentator at another site answered the question this way:
But what year should that income be reported in? While I won the contest in 2010, I won’t be receiving any value from the prize until 2011. Income in the U.S. is based on the concept of constructive receipt. The idea is when you receive something, whether or not you utilize it doesn’t matter; rather, it’s just the receipt that counts. Suppose you receive a check in the mail on December 27th but don’t go to the bank to deposit until the following January. You can’t delay the income because you’re tardy in going to the bank. The income still must be claimed on this year’s tax return.Both explanations leave out an important fact. When was the prize winner permitted to take the trip? If in 2015 a person wins a trip to Paris in April 2016 and must wait until April 2016 to take the trip, then, yes, the value of the trip is included in the person’s 2016 gross income. On the other hand, if in 2015 a person wins a trip to Paris that can be taken whenever the person chooses to do so, then the value of the trip is included in the person’s 2015 gross income even if the person takes the trip in 2016 or even 2017, or even not at all. Without knowing the information in the specific situations described by the commentators, it is not possible to evaluate their responses.
Constructive receipt works in reverse, too. I won’t receive any of the benefits of the hotel room until January 2011. That portion of the prize–the $1,200 that my hotel room would cost if I paid for it directly–should be claimed on my 2011 tax return (due in 2012) as Other Income.
Wednesday, September 23, 2015
When Escaping Tax Isn’t Enough: Grab Some Tax Giveaways
It is disturbing when industries, companies, or individuals find ways to wiggle around basic principles in order to carve out special exceptions that give them advantageous positions compared to the ordinary person. It is a sign of greed, selfishness, and arrogance. It hurts society and civilization, and in the long run it harms even those who set themselves apart as special and deserving of favored treatment. Unfortunately, they lack the ability to see into the future, blinded by their money addiction.
But it’s worse. According to this story, the Pennsylvania legislator most beholden to the gas extraction industry announced that Pennsylvania Republican legislators want to enact legislation that will give tax breaks designed to encourage manufacturers to purchase gas from the gas extraction industry, and to compensate the industry for any revenue losses generated by reductions in the price paid by these manufacturers. So it’s no longer just a matter of escaping the payment of tax, it’s now a matter of taking taxes paid by other people and adding them to the wealth stockpiles of the oligarchy.
There is another twist. This proposal might be a ploy. The governor wants Pennsylvania to join all other states in which gas extraction occurs by enacting a severance tax. The Republicans might be planning to give up their proposal if the governor gives up his. But that outcome is nothing more than a win for the industry and its Republican supporters. The bottom line is that no valid reason exists for letting the gas extraction industry in Pennsylvania get away with a tax exemption that no other state provides. The majority of voters elected a governor who made imposition of the severance tax one of his campaign platform planks. It’s time for the legislators in Harrisburg to heed the wishes of the people and to stop buckling under the demands of a moneyed handful.
Monday, September 21, 2015
More Tax Fraud, This Time in Judge Judy’s Court
In the latest Judge Judy television show that I watched, the plaintiff was suing the defendant to recover money that she claimed she had lent to the defendant. She also was suing for rent. The defendant alleged that the payments were gifts. The plaintiff provided a print-out of an email that the defendant had sent to the plaintiff, in which he acknowledged that the money was a loan. Confronted with this evidence, the defendant admitted having sent the email. As for the rent, he explained that he had moved out in February and thus did not pay March rent even though he did not remove his things until April.
Early in the proceedings, trying to get a handle on the defendant’s financial situation, the judge asked him, “Did you file tax returns last year?” The defendant replied, “No.” So the judge asked, “How di you support yourself?” The defendant responded, “My business is a cash business.” The judge’s reaction was wonderful. She said, “I’m getting a bad feeling about this case.”
Indeed, this exchange between the judge and the defendant resurfaced when the judge explained why she was rejecting the defendant’s claim that he did not owe rent because he had moved out even though his things were still in the premises. She characterized his “I don’t have to pay rent because I wasn’t there even though my things were there” defense to his “it’s cash so I don’t need to pay taxes” way of “dealing with the IRS.” In other words, both his rent defense argument and his approach to taxation were ridiculous and indefensible.
So now that the world, or at least as much of it as is interested in watching and even learning from television court shows, knows who this fellow is and knows that he has not paid taxes on his cash business, will he be audited? Does an IRS employee track these shows? Do the producers of the show send transcripts of the show to the IRS or state revenue departments when tax misfeasance appears?
Friday, September 18, 2015
Tax Simplicity and Complexity in One Case
The taxpayers, a married couple, were respectively a cardiologist and an employee in the cardiology practice. They lived in the Bel Air secton of Los Angeles. In 1992, they purchased a vacant lot in Woodland Hills, in 1997 built a house on the property, and then tried to sell it. Failing to do so, in 2002 they gave up trying to sell it, and rented it for $6,000 per month to an unrelated tenant. Whenthe tenant moved out in 2007, the taxpayers’ daughter moved into the house and paid rent of $2,000 per month, while the taxpayers resumed trying to sell the property.
The taxpayers’ federal income tax returns were prepared by a certified public accountant. He used estimates of deductions that the cardiologist taxpayer provided. On the 2008 return, the taxpayers included a Schedule E, characterizing the Woodland Hills property as rental real estate, reported rent of $24,000, expenses of $158,360, and a net loss of $134,360. The expenses included mortgage interest, taxes, insurance, and depreciation. The loss was characterized as passive.
When he was getting ready to prepare the taxpayers’ returns for 2009 and 2010, the accountant asked the taxpayers about the significant decrease in rental income. The taxpayers explained that the previous tenant had left and their daughter had moved in. On the 2009 and 2010 returns, the gross receipts of $24,000 and $6,000, respectively, expenses of $108,600 and $113,820, respectively, and net losses of $84,600 and $107,820, respectively, were reported on Schedule C, not Schedule E. The taxpayers indicated that they were in the construction business and that the receipts and expenses were attributable to that business.
When the IRS initially examined the return, the taxpayers, following the accountant’s advice, filed an amended return for 2008, shifting the receipts attributable to the Woodland Hills property from Schedule E to Schedule C, claiming a refund. The IRS subsequently issued a notice of deficiency, rejecting the refund claim, disallowing $19,211 of mortgage interest expenses claimed as a deduction for the Bel Air property, and imposing the accuracy-related penalty. Thereafter, the IRS issued another notice of deficiency, for 2009 and 2010, disallowing the Schedule C deductions, adjusting deductions related to the Bel Air residence, and adjusting a deduction for retirement contributions. The IRS determined that the Woodland Hills house was held for the production of income, that the losses were passive, that the taxpayers owed income tax, and that the accuracy-related penalty should be imposed.
The taxpayers filed a petition with the Tax Court. The IRS filed an answer, and subsequently amended the answer to allege that the deductions were limited under section 280A to the amount of the taxpayers’ rental income. The IRS argued that section 280A applied because the taxpayers’ daughter lived in the Woodland Hills house during the years in issue. The taxpayers argued that section 280A did not apply because they were real estate developers and the insurance company providing the homeowners policy required the house to be occupied.
The court held that the daughter’s use of the house was personal and that under section 280A(d)(1) and (2)(A) was attributable to the taxpayers. Accordingly, they did not qualify for an exception to the provision in section 280A(d)(1) that treated the daughter’s use as use of the dwelling unit as a residence. Accordingly, section 280A(a) applied, disallowing the deductions. The court then cited section 280A(c)(5) to concluded that “deductions relating to the Woodland Hills house are limited to the extent of rental income.”
The court imposed the accuracy-related penalty because the taxpayers “did not make a reasonable attempt to comply with the law or maintain adequate books and records relating to their 2008 return.” The 2008 penalty, however, related to the interest deduction on the Bel Air residence, not the Woodland Hills property, and the taxpayers and accountant acknowledged that the deduction was based on the cardiologist taxpayer’s estimate. When it came to the 2009 and 2010 returns, the court sustained the penalty to the extent it related to itemized deductions also based on estimates, but held that with respect to the Woodland Hills property the taxpayers relied in good faith on the accountant’s judgment that the expenses related to that property were fully deductible.
The simple part of the case is that, indeed, the taxpayers were not in the construction or real estate development business and that section 280A applied. The complex part of the case is the absence of any reference to section 280A(b). That provision permits the taxpayers to deduct mortgage interest and real estate taxes even if they exceed the rental income. There are three possibilities to consider. First, perhaps the interest and taxes did not exceed the rental income. That is unlikely, especially in 2010 when the rental income was merely $6,000. Second, the taxpayers failed to raise the section 280A(b) issue. Third, the court simply overlooked section 280A(b). That the taxpayers represented themselves certainly did not improve the chances of section 280A(b) getting attention.
Section 280A is simple in part and complicated in part. The statement by the court, citing section 280A(c)(5), that “deductions relating to the Woodland Hills house are limited to the extent of rental income” is true only if the mortgage interest and real estate taxes on that property were less than the rental income, which I doubt was the case. Otherwise, section 280A(c)(5) is far more complex and cannot be explained correctly in a short sentence. When I teach basic federal income tax, it requires three Powerpoint slides to illustrate how section 280A(c)(5) works, in part because the concept is not simple and in part because the language of paragraph (5) is dense and inexplicably convoluted. My attempt to translate the provision into English reduces the complexity but cannot eliminate it because the concept underlying section 280A(c)(5) is complicated. It is not difficult to imagine why the taxpayers in this case, and perhaps the court, got lost in the maze of section 280A.