Wednesday, September 25, 2013

Civil War Horses, Con Men and Lois Lerner



I think I have been insulted.

I am reading this morning that the Court of Appeals for the D.C. Circuit is hearing the IRS appeal of the Loving decision.  That decision concerned the recent effort by the IRS to regulate tax preparers, and the IRS lost the case. There were three parts to the IRS effort:
  • a unique preparer identification number, called a PTIN (“pea tin”). The PTIN would allow – in theory - the IRS to track which individuals prepared which returns. I say “in theory” because it is not uncommon for larger returns to have two or more preparers and one or more reviewers. Traditionally the highest-ranking last person in the chain is considered the official preparer, but the IRS did not write its regulations that way.
  • a competency test. CPAs, enrolled actuaries, attorneys and enrolled agents were exempt, as their credentialing already includes a competency test.
  • a continuing education requirement. Tax laws change frequently, so the IRS thought that continuing education would be a good idea. It is.
Here is the rub: where does the IRS get the authority to make these proclamations? I know it sounds a bit quaint to talk about “government of laws rather than of men” in the current political environment, but there are a few sticklers out there who still believe in the concept. One of them was Judge Boasberg in the Loving decision.

Yesterday the IRS trotted out its attorneys, arguing that they have the right to regulate whatever they want under the “Horse Act of 1884.” Folks, that is “18” 84. 

Do you remember the following words?

The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”

This is the 16th amendment, creating the income tax and ratified in February 1913. That is “19”13. Which comes after “18”84, for most people. Let’s be blunt here: how can a law from the 1800’s give the IRS any authority over income tax preparers when the income tax was not even created until 1913?

I have to admit, I had to look up the Horse Act of 1884. We must have missed that bright shiny in high school American History. After the Civil War, people brought claims against the U.S. for dead or missing horses. Makes sense, as horses were required to work the farm or for transportation, and their loss would have been keenly felt. Always seeking a vacuum, fraudsters soon appeared to help people press horse claims against the government. Soon all horses were thoroughbreds, and the government was facing more actions than there were horses lost in the Civil War. The government realized they were being scammed by con men and, in defense, starting regulating those people. The government even used the term “enrolled agent,” a term still used today for a class of preparer who has passed a competency examination given by the IRS itself.


So the IRS attorneys are arguing that tax CPAs like me are akin to fraudsters who inflated the value of dead or missing horses in action against the government following the Civil War?

As I said, I think I have been insulted.

I am also reading that Lois Lerner, the former head of the IRS Exempt Organizations Division, is retiring. You may remember that she invoked the Fifth Amendment when appearing before Congress on May 22, 2013. She was the political hack from the Federal Elections Commission who somehow wound up at the IRS reviewing and delaying applications from conservative groups, especially Tea Party organizations, seeking 504(c)(4) status in time for the 2012 presidential election. Good thing she was there too or the election may have gone a different way. She was quite happy to initially throw a few Cincinnati IRS employees under the bus, saying they had gone “rogue.” Later investigation, including e-mails, put a rest to that lie. Congress could have instead spoken with a few practicing tax CPAs, and we could have told them the same thing.  

She has been on “administrative” leave since then, drawing an approximate $170,000 salary. Now she gets to retire. It’s a nice retirement too, as she able to look for another government position and still collect her retirement pay, estimated over $50,000 annually. 

I would love a deal like that. Unfortunately, the IRS thinks of me as a con man.

Wednesday, September 18, 2013

State Tax Absurdities: California's Time Travel Laugh-In


I do enjoy following tax developments out of California, as they are so … so…. How to be diplomatic? Think Rowan & Martin Laugh-In reruns – entertaining, but in a time-travel sense. Hearing “groovy” seems a bit imbecilic after all these years, and surely, McGovern is not still running for President, is he? Why then does California continue to give the same answer to every problem - “tax them more?”


Here are a couple of tax grenades that California has thrown out there recently:

1. There is an Iowa corporation (Swart) that owns farms in Kansas and Nebraska. It also has a few investments, one of which is a 0.02% interest in a California LLC (“Cypress”) that bought and sold capital equipment across several states.  Mind you, Swart did not exercise any management or control over its investment. This would be the equivalent of you investing in a California REIT (a REIT is an investment that owns real estate, such as apartment buildings). The California Franchise Tax Board nonetheless contacted Swart and told them that their investment in Cypress was “enough” to require them to file a California LLC tax return.
So what, you are thinking. Here is what: California imposes a minimum $800 annual fee on an LLC tax return.
Think about the numbers for a moment. Let’s say that Cypress made a tidy profit. We need a number. How about $4 million? Swart’s 0.02% share would be $800, which coincidentally is the same as California’s minimum fee. Not to mention the fee for an accountant to wade through this.
Swart filed suit on July 9, 2013, so we do not yet know the outcome.
California’s interest is obvious, duplicitous and mercenary: it wants money. Your money, if you stand on that street corner long enough. Cypress alone has 384 other members who are California nonresidents. 
It is also self-defeating. Tax Analysts summarized it well:
While states are always on the lookout for each and every dollar of tax revenue, taxing investments in California serves as a big disincentive for out-of-state companies to invest in the state.”
2. Do you know what a Section 1031 exchange is? This is where you exchange one property for another, and the government gets no taxes. More accurately, the tax effect is “deferred.” An easy example would be swapping one office building for another.
Don’t get me wrong here: a 1031 has all kinds of rules and sub-rules which, if you get them wrong, will transmute your tax-deferred exchange into a fully taxable event. I wanted only to introduce the concept.
Let’s say that you own an office building in Burbank. You swap it for another in San Antonio, Texas. The IRS doesn’t care that you moved states. California does care, though. The Laugh-In time travelers in Sacramento have passed a new tax law. Beginning in 2014, you will have to file an annual report if you exchange California property for non-California property in a Section 1031 exchange. The forms do not exist yet, but they will … and soon. You will have to acknowledge that you still own the replacement property. If you do not, California will assess you a tax.
Think about that for a moment. Let’s say that Steve Hamilton, a tax CPA in the Napa Valley swaps California for Florida real estate. Years go by, and as part of his estate planning, and preparatory to retiring to Ireland, he places the Florida real estate in a family limited partnership.  Is California REALLY going to send him a tax bill? And why would he pay it? What are they going to do: stop him at the airport?
In graduate school (many years ago), we discussed an efficient tax system as having the least drag on economic decision-making and the fewest reductio ad absurdum conclusions.  Sacramento needs to get back to the future with its tax policy, as they are stuck in a time warp.

Groovy.

Wednesday, September 11, 2013

Is It A Bad Thing To Be A Resident Of Two States At The Same Time?



A state tax issue came up with a client recently, and I was somewhat surprised by another CPA’s response.  The issue arises when someone has tons of interest and dividend income – that is, big bucks, laden with loot, banking the Benjamins.  Since I consider myself a future lottery winner, it also means something to me.

Here it is:
           
Can you be a resident of two states at the same time?

The other CPA did not think it possible.

There are a couple of terms in this area that we should review: domicile and place of abode. Granted in most cases they would mean the same thing. For the average person domicile is where you live. You are a resident of where your domicile is located. We future lottery winners however frequently will have multiple homes.   I intend to have a winter home (New Mexico comes to mind), a summer home (I am thinking Hawaii) and, of course, one or more homes overseas. Which one is my domicile? Now the issue is not so clear-cut.

OBSERVATION: Let’s be honest: this is a high-end tax problem.

Domicile is your permanent home. It is the place to which you intend to return when absent, to which your memories return when away, it is home and hearth, raising children, Christmas mornings and planting young trees There can be only one. A domicile exists until it is superseded, and there can never be two concurrent domiciles. It is Ithaca to Odysseus. It took Odysseus ten years to get home from Troy, but his domicile was always Ithaca. The concept borders on the mystical.

A place of abode can be an apartment, a cottage, a yacht, a detached single-family residence. There can be more than one. I intend to have abodes in New Mexico, Hawaii and possibly Ireland. My wife may pick out another one or two.


Most states (approximately 30, I believe) use the concept of “domicile” to determine whether you are or are not a “resident” of the state. You can generally plan for these states by pinning down someone’s “main” house.  A state can tax all the income of a resident, which is what sets up the tax issue we are talking about.

Then you have the “statutory” states, among the most aggressive of which is New York. New York will consider you a resident if:

(a)  Your domicile is New York, or
(b) Your domicile is not New York, but
a.     You maintain a permanent abode in New York for more than 11 months of the year, and
b.     You spend more than 183 days in New York during the year

That “or” is not there because New York wants to be your friend. That (b) is referred to as statutory residency. It is intentional, and its intent is to lift your wallet.

How? It has to do with all those interest and dividends we future lottery winners will someday have.

Let’s say that you live in Connecticut and work in White Plains. You are going to easily meet the “more than 183 days in New York” test. Unless you work at home. A lot. Let’s say you don’t.

We next have to review if you have a “permanent abode.” What if you have a vacation home in the Hamptons. What if you have an apartment in Brooklyn. What if you rent an apartment (in your name) for your daughter while she is attending Syracuse University. Do you have a permanent abode in New York? You bet you do. The “permanent” just means that it can be used over four seasons. We already discussed the meaning of “abode.”

Think about that for a moment. You may never stay at your daughter’s apartment. It will however be enough for New York to drag you in as a statutory resident because you “maintain” it.  New York doesn’t care if you ever actually stay there – or even step foot in it.

Great. You are a resident of both Connecticut and New York.

So what, you think. Connecticut will give you a credit for taxes paid New York. New York will give you a credit for taxes paid Connecticut. The accountants’ fee will be wicked, but you are not otherwise “out” anything, right?

Wrong. You may be “out” a lot, and it has to do with those interest and dividends and royalties and capital gains – that is, your “investment income.”

There is a state tax concept called “mobilia sequuntur personam.” It means “movables follow the person,” and in the tax universe it means that movable income (think investment income, which can be “moved” to anywhere on the planet) is taxed only by one’s state of residence. The system works well enough when there is only one state in the picture. It may not work so well when there are two states.

The reason is the common technical wording for the state resident tax credit. Let’s look at New York’s wording as our example:

A resident shall be allowed a credit …for any income tax imposed for the taxable year by another state …. upon income both derived therefrom and subject to tax under this article."

The trap here is the phrase “derived therefrom.” Let’s trudge through a New York tax Regulation to see this jargon in its natural environment:
           
The term income derived from sources within another state … is construed as ... compensation for personal services performed in the other jurisdiction, income from a trade, business or profession carried on in the other jurisdiction, and income from real or tangible personal property situated in the other jurisdiction."

Well, isn’t that a peach? New York wants my interest and dividend income to be from personal services I perform (that’s a “no”), from a trade, business or profession (another “no”) or from real or tangible property (again a “no”).

New York will not give me a resident credit for taxes paid Connecticut.

That means double state taxation. 

Yippee.

Can this be constitutional? Yes, unfortunately. The Supreme Court long ago decided that the constitution does not prohibit two states reaching the conclusion that each is the taxpayer’s state of residence. The Court stated:

“[n]either the Fourteenth Amendment nor the full faith and credit clause … requires uniformity of different States as to the place of domicile, where the exertion of state power is dependent upon domicile within its boundaries.” (Worcester County Trust Co v Riley)

What did we advise? The obvious advice: do NOT be in New York for more than 183 days in a calendar year NO MATTER WHAT. 

Our client’s apartment is in Manhattan, so she also gets to pay taxes to New York City on top of the taxes to New York State. I hope she really likes that apartment.

BTW New York is NOT on my list of states for when that future lottery comes in.

Tuesday, September 3, 2013

Did You Hear That Spain Is Taxing The Sun?



It has been a while since we have played “Are They Smarter Than a Garden Gnome?” Our blog today involves a near-bankrupt government, which pressed the metal to the floor with “renewable energy” and “green” subsidies. It has now taken the preposterous – and possibly first-time-in-human-history- act of taxing the sun.

You think I am kidding. You may also think I am talking about the United States, but I am not. At least, not this time.

We are talking about Spain, one of the sunniest places in all of Europe. It is a likely candidate for photovoltaic and solar-thermal power generation – that is, solar panels. It sounds good on first hearing. That of course is before the government got involved.

In 2007 Spain had 701 megawatts of installed solar panels. I do not know if that is a lot, but I do know that the Spanish government wanted to increase the amount. Not having a Solyndra or Satcon Technology on which to throw away tax money, they decided to push solar power.  That meant that they paid more for solar-produced power than for other power – think coal, hydroelectric, nuclear, air draft from flocks of geese. How much more? Think 12 times more than conventional power. Yipes! The government was unwilling to pass the full cost onto the populace, even though Spanish power producers have some of the highest rates in the EU. The government instead ran up subsidy deficits now totaling 26 billion euros.

Well, they did increase solar power generation. Current production is 4,000MW, which is an impressive increase from 701MW in 2007.  

What could possibly go wrong with subsidizing solar? After all, it is renewable, environmentally sustainable and so forth.  

Well, when you are paying 12 times more than something is worth, you better not buy too much of it. Unfortunately, Spain missed this lecture. The Spanish government has its fingers all into and over its energy industry. There are mandates for clean energy, for idle gas-fired plants, for poor families and for island dwellers. As a consequence, the government is now about 35 billion euro in the hole from its subsidies. To exacerbate matters, Spain is entering its second recession in three years. The government has recently announced spending cuts and tax increases of 100 billion euros. Unemployment has reached 25 percent. Spain, strapped for cash, is now looking to cut back.

What to do, what to do?

Got it! Spain will tax the electricity produced by home solar panels. Homeowners will have to connect their panels to the grid so their production can be metered – and billed back to them, of course. The effect is to make self-generated power more expensive than power purchased from the grid. 

How much more are we talking about for an average Spanish household? Approximately 27 percent more.

Spain’s Industry Ministry justified this action by explaining that – even though you may be self-sufficient – you “benefit” by having the back up provided by the power grid. Not everyone will be affected, however – only those Spaniards living within reach of the power grid. If you live in remote areas, you will be untouched by this.

Oh, well. Maybe you can sell your power back to the grid and offset somewhat this new cost. No can do. Spain will not allow that. You will have to move to Germany if you want to sell your excess power.

What if you refuse to connect to the grid? Spain reserves the right to fine you up to 30 million euros. Yipes! There has been pushback by consumer groups clarifying that this fine was created in 1997 by a law intended for large corporations, not private individuals. Someone will have to take that theory to court, however, to test how sound it is. I can assure you that it would not be me.

The sad part is that there is nothing here that a clear-headed person could not have seen coming from a mile away, or at least since 2007. Every government benefit given in turn is taken from someone else. This is the economics of taxation, and in the end economics won out. The Spanish government is now scrambling to keep all the spinning dishes from hitting the ground.

What do you think: are they smarter than a garden gnome?