Friday, November 30, 2012
You may have read or heard that Lance Armstrong has been stripped of his seven Tour de France victories because of doping. The UCI Management Committee stated that it would not award the titles stripped from Armstrong to any other riders. History books will show no winner of the race between the years 1999 and 2005. UCI has demanded that Armstrong return his winnings from the vacated years, an amount estimated at approximately $4 million.
SCA Promotions, a Dallas insurance firm, has indicated that it will demand repayment of bonuses it insured for Armstrong’s wins in 2002, 2003 and 2004. It is reportedly seeking approximately $12 million.
There wasn’t much goodwill between SCA and Armstrong to begin with. SCA delayed paying a $5 million bonus for his 2005 win, responding to then-swirling allegations and controversies surrounding possible drug use. Armstrong sued, and SCA settled the case.
Then there are the endorsements. Armstrong earned more than $17 million in endorsements and speaking fees in 2005, when he won his last Tour de France. That amount grew to an estimated $21 million in 2010. And do not forget that Armstrong was the founder and driving force behind the Livestrong Foundation, which assists those struggling with cancer. Nike, Honey Stinger and Easton Bell Sports have dropped his endorsement, for example, and make seek clawback of prior monies.
Let us suppose that Armstrong has to repay some of these monies. What are the tax consequences to Armstrong?
The first step is easy: Armstrong will be entitled to a deduction. The repayment is tied to monies originally earned in his trade or business as a cyclist or spokesman, so the tax linkage is clear.
The second question is one of tax benefit. Armstrong paid taxes on these monies in prior years. Can he go back and have the IRS refund those monies? There is the rub. What would be your argument for amending those tax years?
You: He had to repay those monies.
Me: Did he not have unrestricted access to those monies in the prior year?
You: I am not saying that. He did, but now he has to pay it back.
Me: So is the transaction we are talking about for the year he received the money or the year he pays it back?
You: What is the difference?
Me: He earned it in 2004 but pays it back in 2013. What year do you amend?
You: You cannot amend 2013. It hasn’t happened yet.
Me: So you would amend 2004?
Me: There are two issues. The IRS is going to have a problem with your argument that he did not receive the money and owe tax. He did receive the money. And the IRS will expect its tax, because in 2004 he had no reason to think that he wasn’t entitled to keep the money.
You: What is the second issue?
Me: You cannot amend 2004. Remember, a tax year is open for only three years. The statute period has long since expired.
You: So I am stuck with 2013?
Me: That’s right.
Let’s pursue this point of tax benefit a bit further. Let’s say that Armstrong was in the maximum tax bracket in 2004. Let’s also say that his income for 2013 is not what it was in 2004. How much tax does he recoup from repaying prior winnings? You guessed it: whatever the deduction saves him in 2013, which can be a very different – and much smaller – amount than what he actually paid in 2004.
You: That doesn’t seem fair!
Me: There is one more tax option.
That option is IRS Section 1341, sometimes referred to the “claim of right” section. The “claim of right” concept is something akin to “I thought at the time that the money was mine to keep.” Section 1341 gives one the option to:
(1) Deduct the payment in the year of repayment, or
(2) Calculate a hypothetical tax, excluding the repaid income from the tax year originally received. That gives one a change in tax. One then calculates the tax for the year of repayment, not including the repayment itself, and subtracts the previously-calculated change in tax from that tax.
Me: Let’s use an example. Say that Armstrong repays $3 million in 2013. Let’s further say (to keep this easy) that the entire $3 million was attributable to 2004 winnings and endorsements. We go back and recompute his 2004 income tax excluding that $3 million. Let’s say his tax goes down by $1,050,000 (3,000,000 * 35%).
You: OK, so he gets a $1.05 million tax break.
Me: Not yet. There is another step.
Let’s say that his 2013 taxable income is also $3 million. We estimate his 2013 tax on the $3 million to be $1,027,000 (granted, no one can guess what taxes will be). His tax benefit is limited to $1,027,000, not the $1,050,000 from 2004.
You: So he loses over $22 grand. That isn’t too bad, all things considered.
In our example, you are right. The $22 grand is small potatoes. But we used a very simple example.
Let us complicate the scenario. What if the athlete’s knock-it-out-of-the-park income years are behind him or her? Let’s use a football player. Say that he had an 8-year NFL career. What if he has to pay back $2 million several years after retirement? It is very possible that he will never again be in the same tax bracket as when he was playing. That said, he would never get back the actual tax he paid on the income, whether one uses Section 1341 or not.
Let’s use another example. What if our athlete was frugal and saved his/her career earnings? He/she now has a very attractive portfolio of tax-exempt securities and dividend-paying stocks. Let’s say that the portfolio will generate $2 million in 2013. He/she pays back $2 million. What do you see? Tax-exempts are – well, tax-exempt. Their tax rate is zero. Next year tax rates on dividends may go to the maximum rate. Let’s say they do. He/she will offset the maximum rate on the dividends, but remember that dividends are only a part of the $2 million the portfolio is earning. He/she is still not whole.
Section 1341 many times helps, but there is no guarantee that one will get a tax break equal to the tax actually paid when one received the income.
P.S. Armstrong resigned from the Livestrong board of directors on November 4. He had previously resigned as chairman on October 17 but had kept a seat on the board.
Saturday, November 17, 2012
I have noticed that more and more states are increasingly requiring individual income tax refunds to be electronically deposited or received on a debit card.
What got me thinking about this is Virginia’s decision to require electronic refunds, beginning with the 2013 tax season. One can have his/her refund electronically deposited or loaded onto a debit card. There will be no physical checks.
Virginia is joining Louisiana and Oklahoma with its electronic refund/debit card policy.
I find myself recalling IRS issues with identity theft and debit cards this past filing season. The IRS has estimated that more than $5 billion was refunded to identity thieves in 2011. A majority of these cases used direct deposits, including debit cards. Thieves prefer debit cards to a paper check, which may require a photo ID matching the taxpayer’s name to cash it. Makes sense.
So what does the identity thief need? He needs a name and social security number, preferably from someone who will not be filing a tax return. An address would also be nice. Find a foreclosed house. Maybe put a new mailbox on it. The thief fills out a tax return, making up the wages, withholdings and so on. As long as he is the first person using the identity for the tax year, it is – as one U.S. Attorney phrased it – a “remarkably simple crime to commit.” Couple this with a hard-to-trace debit card, and the IRS is almost sending cash through the mail.
Do you find yourself wondering how it is cheaper for a state to issue debit cards rather than a physical check? Say that Kentucky issues 1,200,000 refunds using physical checks. Kentucky has the cost of the checks, plus equipment, personnel costs and postage. If Kentucky associates with a debit-card-issuing institution (I am thinking the to-be-formed Hamilton Bank of the Bluegrass, as an example), they instead send one transfer to The Hamilton Bank, as well as a data base of the individual refunds. No mess, no fuss. One can see the savings to Kentucky.
I would – I mean The Hamilton Bank of the Bluegrass would – issue the debit cards. How does The Hamilton Bank make money? First, there would be the float while the debit cards carry balances. Second, there could be merchant fees upon use of the card. Third, The Hamilton Bank would allow one to withdraw cash, but only at conveniently-located-Hamilton-Bank-ATM locations in greater Cincinnati, northern Kentucky and the Bluegrass. Any other ATM’s would trigger a fee. Fourth, The Hamilton Bank would charge fees for inactivity, replacement cards and etc. I am thinking this could be a sweet deal for me, er… I mean The Hamilton Bank of the Bluegrass.Kidding aside, I do understand the states’ interest in moving tax administration to an all-electronic format. Practitioners have already seen some of the advantages of electronic processing: verification of receipt and filing, record of filings and payments, transcript deliveries and etc. Electronic refunds fit into this structure. However, the government cannot electronically refund to someone who does not have a bank account, which is how we wind up talking about preloaded debit cards.
Thursday, November 15, 2012
The Tax Foundation has published an analysis on the impact of the tax cliff on a typical family in each state.
To arrive at the typical family, the Tax Foundation used Census and IRS data to estimate income and deductions for an average two-child family in each state.
They then ran those numbers through two tax calculations: the first using 2011 tax law, and the second using projected 2013 law. The rub of course is the 2013 law, as Bush-era and Obama tax cuts are expiring. It is unknown what, if anything, will take its place. This is the “taxmaggedon” you may have read about. Another key piece to 2013 is the alternative minimum tax (AMT), as the most recent AMT “patch” expires with the 2012 tax year.
The rankings go from #1 to #50, and one does not want to be #1. That dubious distinction goes to New Jersey, not exactly an economical place in which to live under the best of circumstances.
In our corner of the world, the TriState area (Ohio, Kentucky and Indiana) came in as follows:
$ Increase % Increase
Ohio $3,437 4.72%
Indiana $3,653 5.27%
Kentucky $3,437 5.18%
So – if the politicians accomplish nothing – the tax cliff will cost the average TriStater approximately $300 per month. This is real money, folks.
Wednesday, November 14, 2012
There seems to be an international flavor to our blog this week. We last discussed the Carrot Rebellion. Let’s now discuss the “Fat Tax” and “Nutella Tax.”
Truly, I am not making this up.
About a year ago Denmark implemented a tax on all foods with saturated fat content above 2.3 percent. Its intent was to reduce the consumption of unhealthy foods; you know, like butter, sausage, cream and cheese. Apparently mankind has been on a one-way road to health perdition since we domesticated animals.
The tax didn’t go particularly well. While it did raise over $210 million, many Danes took to lower-cost alternatives or simply crossed the border into Germany. An additional advantage to Germany was that prices are approximately 20% lower.
This past Saturday Denmark announced that it was abolishing the tax, since it was having the negative consequences of inflating food prices and putting jobs at risk. The government further announced that it was cancelling its plans to further tax sugar.
Do you ever wonder how much ideological kool-aid one must drink to not have seen this coming?
That brings us to France.
Have you heard of a product called Nutella? It is made of chocolate and hazelnut, not a personal favorite. Senators in France have called for a major tax on palm oil (think 300%), which is a principal ingredient in Nutella. The tax has become known as the “Nutella Tax.” There are some bad things associated with palm oil, including deforestation pressures in Borneo and Indonesia. I agree – deforestation is a bad thing. So are droopy pants in public. Neck tattoos. Loud vulgar music. Inane cell phone calls in the grocery aisles.
I am thinking palm oil doesn’t even make the top 300 list.
Tuesday, November 13, 2012
You may have heard that Spain has gotten itself into an economic mess. In an effort to avoid more stringent EU austerity measures, it has increased a number of taxes. The one that interests us today is the value-added tax. The VAT on selected foods is 4%, whereas the VAT on clothing went from 18 to 21%. The VAT on theater tickets also went to 21%.
There is a village called Bescano in Catalonia. Catalonia is in the northeast part of Spain, adjacent to France, and it boasts a strong separatist sentiment. On September 11, which is Catalonia’s National Day, an estimated 1.5 million people filled the streets carrying signs such as "Catalonia, the next independent state in Europe." A recent poll showed that 51% of Catalans would vote in favor of separating from Spain.
Bescano is a small village, but it boasts an impressive theatre troupe. Problem is that one in four local residents is unemployed, which makes it difficult to sell theater tickets. Increase the VAT to 21% and you have a near-insurmountable problem. What to do?
The theater decided to sell a carrot as admission to the theatre. The carrot costs over $15, but it entitles one to free admission. The VAT on a carrot? It is 4%.
The Spanish media have called this the “Carrot Rebellion,” and there is the expected tut-tuts from government officials. Each person who does not pay his “fair share” raises the burden on everyone else, or so goes the party line. It may even constitute “tax evasion,” says one.
The theater has the support and backing of the local mayor.
My thought? No disrespect to a difficult fiscal situation, but I find it clever.
Monday, November 12, 2012
The IRS has announced selected business areas it is prioritizing for audit this upcoming fiscal year. The IRS is increasingly focused on small business underreporting, which it considers responsible for the majority of a $450 billion tax gap. Here are the areas:
1. Fringe benefits, especially use of company cars
The IRS is finding that employers are not correctly reporting employees’ personal use of company vehicles on Forms W-2.
2. Higher income taxpayers
The IRS will focus on self-employed taxpayers with gross receipts (that is, before expenses) of more than $1 million.
3. Form 1099-K matching
Forms 1099-K report payments from credit cards and payment clearinghouses (such as PayPal). The IRS granted a reprieve for 2012, but it announced that it will start Form 1099-K matching in 2013.
4. The small business employee health insurance tax credit
The IRS wants to make sure that small business employers and tax exempts are complying with credit eligibility requirements.
5. International transactions
The IRS has announced its third voluntary foreign bank account initiative and intends to look for offshore transactions.
6. Partnership returns reporting losses
This is a new area of emphasis. Expect the IRS to look into partnerships reporting large losses.
7. S corporations reporting losses and reasonable officer compensation
The IRS will be looking at S corporations claiming losses, looking for losses taken in excess of shareholder basis.
The IRS is also interested in profitable S corporations reporting little or no salary to officers.
8. Proper worker classification
The IRS is interested in employer treatment of worker versus independent contractor status. The IRS thinks there is significant noncompliance in this area.
Thursday, November 8, 2012
A CPA acquaintance from New Jersey came into town and spent a couple of days at the office. Why? Well, maybe he wanted to get away from New Jersey. Actually, he wanted to take a look at some of the policies and procedures we utilize. He only recently purchased his own practice.
He said something that surprised me, and which I thought we could discuss this week. He funded his accounting practice by using his 401(k) funds. This technique is sometimes referred to as “rollover for business startup.” The acronym is “ROBS.” Catchy, eh?
What do I think about ROBS? Frankly, I am a bit uncomfortable with them. There is the issue of concentrating your retirement monies in a venture also intended to provide current income. Should it fail both income and retirement monies vanish. I am financially conservative, as you can guess.
The second issue is technical: there are a number of ways this structure can run afoul of some very technical requirements. You have tax law, you have ERISA, you have … well, you have enough to cause concern.
Let’s give this CPA acquaintance a name. We will call him “Garry,” mostly because his name actually is Garry. Here is what Garry did:
(1) Garry created a corporation. The corporation had no assets, no employees, no business operations, no shareholders. Accountants call this a “shell” corporation.
(2) The corporation adopted a retirement plan. The plan allowed for participants to invest the entirety of their account in employer stock.
(3) Garry became an employee of the corporation.
(4) Garry rolled-over his 401(k) (or a portion thereof) to the newly-created retirement plan.
(5) Garry had the plan purchase the employer stock.
(6) The corporation now had cash, which …
(7) The corporation used to purchase an accounting practice.
What can possibly go wrong? Here are several areas:
(1) You need a solid valuation for the 401(k) purchase of the employer stock. I would not want to go into the IRS with only a rough calculation on the back of an envelope. The trustee of the plan has fiduciary responsibility. Granted Garry is both the fiduciary and beneficiary, but he still has responsibilities as trustee.
(2) The workforce has to be able to participate in the plan.
a. This is a qualified plan. There are nondiscrimination requirements, same as any other qualified plan.
b. This is not a problem for a one-man shop. What will Garry do when he hires, however?
i. Here is what he better do: amend the plan to prohibit further investment in employer stock. Future employees will not be allowed to invest in Garry’s accounting firm stock.
(3) There is a fiduciary standard for investment diversification.
a. You can see the problem.
i. Maybe Garry can open a second accounting office. You know, diversify.
(4) Garry is paying for all this. Some brokers will charge over $5,000 to set up a ROBS.
a. Oh, there are also ongoing annual charges. The plan will have an annual Form 5500 filing requirement, for example.
b. There may also be periodic valuations, requiring Garry to pay a valuation expert.
i. Why? Because Garry has a difficult-to-value asset in a qualified plan. Difficult-to-value does not mean Garry gets a free pass on valuing the asset. It does mean that it is going to cost him.
(5) These transactions have caught the attention of the IRS. This does not mean that his transaction will be audited, challenged or voided, but it does mean that he has walked into a spotlight.
a. Garry had to gauge his IRS risk-tolerance as well as his financial diversification risk-tolerance.
Are ROBS considered “out there” tax-wise? Actually, no. There are tens of thousands of these structures and their businesses up and running. Garry is in good company. And while the IRS has scowled, that doesn’t mean that ROBS are not viable under the tax code and ERISA. It does mean that Garry should be careful, though. Professional advice is imperative.
Tuesday, November 6, 2012
Heads up if you file tax returns with South Carolina.
On October 26 the S.C. Department of Revenue announced that approximately 3.6 million social security numbers and almost 400,000 credit and debit card numbers were compromised.
Government officials emphasized that no public funds were accessed or put at risk. No word from government officials on your whether your private funds were put at risk, though.
On October 10 the S.C. Division of Information Technology informed the Department of Revenue of a potential cyber attack. On October 16, investigators discovered two attempts to hack the system in early September. They later discovered that a previous attempt was made in late August. Government officials believe they have closed the vulnerability in the system.
If you have filed a South Carolina tax return since 1998, please visit protectmyid.com/scdor or call 1- 866-578-5422 to determine if your information is affected. If so, you can immediately enroll for free in one year of identity protection service with Experian.