What Will The Tax Cliff Cost You?

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.

The Fat Tax and Nutella Tax

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.

The Carrot Rebellion

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.

IRS Small Business Audit Areas

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.

“ROB”-ing a 401(k) Plan

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.

Do You File Taxes With South Carolina?

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.

Happy Halloween

Amost forgot. Time to clear here and pass out candy.

Barriers to Tax Reform

The New York Times ran an article yesterday titled “The Real Barrier to Tax Reform” written by Bruce Bartlett. I have no issue with Mr. Bartlett, although I rarely read The New York Times. Nonetheless, what caught my eye is the following table of “tax expenditures”:

These “expenditures” make it difficult to raise enough “revenues” to cover whatever the government’s spending binge of the moment is.

I can see how reasonable people may debate the tenth – accelerated depreciation – as an expenditure. Instead look at categories such as the 401(k), medical insurance and employer-provided pension plans.

 A couple of observations on this:

(1)   Since when are monies taken from us as taxes to be called “revenues?”

(2)   Since when are monies we keep to be called “expenditures?”

There is an odor of bad fish with the vocabulary. Apple has revenues, as they have something I want and am willing to pay for. The government - not so much. This damage to the language is itself a barrier to tax reform.

Oh, you may be wondering about “exclusion of net imputed rental income.” Here is the concept: if you rented out your home rather than lived in it, someone would pay you rent. The government would then tax you on your rent. So, by living in your home rather than renting it out, you are costing the government money.

You, dear homeowner-living-in-your-home, are an “expenditure.”

Bruce Bartlett "The Real Barrier to Tax Reform"

Michael Bennett and an FBI Sting

Here is another former-NFL-player goes wrong tax story: Michael Bennett has been convicted of wire fraud and will serve 15 months in prison.

Who is Michael Bennett? He was drafted by the Minnesota Vikings in the first round of the 2001 draft. He was a Pro Bowl player. He was in the NFL until 2010, although he was a backup player for much of the time. Still, he earned millions of dollars from football. May we be so lucky.

How did he get arrested? It has to do with identity theft and tax refund fraud in North Miami. South Florida is a hotbed for tax refund fraud, and the FBI was operating a tax-refund and check-cashing storefront. It sounds like the business was quite lucrative, as the FBI was charging fees ranging from 35% to 45% of the face value of the checks. People would go the store and cash fraudulently-obtained checks, presenting false identification and sometimes forging the victim’s signature on the back of the check.

There was one ring of seven people which cashed approximately $500,000 of refund checks. The FBI caught the conversations and transactions on tape. Sadly, two former NFL players were in this crowd. Perhaps that is how we get to Michael Bennett.

In walks Bennett. He is not part of the tax-refund ring, but he does want to borrow money. He wants to borrow $200,000. I can understand. Surely many of us have been returning from lunch and decided to stop in at the cash-and-dash to borrow a couple of hundred grand. Bennett presents a bank statement showing that he had buckets of bucks at UBS, and the statement is accepted as “collateral” for a loan. On April 30, 2012 Bennett picked up a $150,000 check. He was supposed to pay back $280,000 after three months.

NOTE: Yes, I wrote the amounts correctly.

There was no money in his account, of course. Bennett admitted to altering his UBS statement to make it look like he had a lot of money there. He was arrested for wire fraud. He has until January 18, 2013 to begin serving his sentence.

My Take: Sad.

Thanks to Russ Fox for his post

A TIGTA Report on IRS Contractor Payments

The Treasury Inspector General for Tax Administration (TIGTA) has released a new report titled “Deficiencies Continue to Exist in Verifying Contractor Labor Charges Prior to Payment.”

What happened is that the IRS received appropriations from the American Recovery and Reinvestment Act of 2009. You may remember this Act by another name – the “Stimulus.” TIGTA was auditing certain expenditures and also reviewing IRS internal controls over contract review, approval and payment.

TIGTA selected a statistical sample of $1 million in labor charges. What did it find?

(1)   The IRS could not document $394,430 of invoiced labor hours that were paid.

(2)   The labor rates paid were not verified to the contract for the qualification level of the individual paid.

(3)   Although the IRS verified the qualification and experience of key contract personnel, they did not do so for other personnel. The IRS was supposed to do this by the contract.

My Take: I am glad that someone is keeping an eye on these expenditures. An error rate of 39.4% is not too reassuring, however.

A Wake for Flanagans

Have you got a restaurant to sell? If you do, you may want to hear the story of John Psihos (JP) and Flanagan’s Restaurant.

JP was a Greek immigrant who came to the U.S. in his 20s. He did very well and eventually owned three restaurants in the north Chicago area: Flanagan's, Cafe Oceana and Full Moon. Flanagan's was the most successful. He seemed to be a good employer, willing to help his employees. He was also generous in his charitable pursuits.

The problem was that JP was keeping a double set of books on Flanagan’s. He used the second set to prepare his tax returns, a ruse undetected until he tried to sell the restaurant. JP listed the restaurant through a broker, providing a fact sheet showing his average monthly receipts at $170,000 and average yearly operating profit at approximately $554,000. These numbers were from the first set of books.

This caught the IRS’s attention.

The IRS dispatched two special agents who posed as husband and wife. They met three times with JP, who explained how he kept track of the actual receipts at Flanagan’s. Each night at closing the managers would assemble envelopes with all of the money, as well as receipts, register tapes and payout sheets. Standard stuff for a restaurant. JP then provided this material to one of his managers, who prepared weekly summaries. JP, feeling brave, provided these summary sheets to the two “buyers,” stating further that he had these records going back to 2001 showing what he “really got” from Flanagan’s.

The two agents executed a search warrant on one of JP’s restaurants, seizing, among other things, the weekly summary sheets. They also seized records detailing Flanagan’s nightly sales and cash payouts. The IRS reviewed these records to recalculate the actual gross receipts for years 2001 through 2004. They determined that JP had underreported his receipts by over $3 million over the four years. He was indicted on felony charges by a federal grand jury.

One has to give JP credit for the chutzpah he displayed before the District Court. He argued that he had left out all kinds of expenses, such as:

·        Amounts paid to DJ’s

·        Cash wages

·        Complimentary food and drinks

·        Payments to Café Oceana for food supplied

He even prepared a chart which he presented to the Court. According to his analysis, the actual loss to the government was approximately $22 thousand. He argued that the Court had to give him credit for the expenses he didn’t claim because, well, you know, he hadn’t wanted to double dip. He had a conscience, after all. The Court was having none of this and observed that the expenses were undocumented except for his word and that his word was not credible. The Court ordered him to pay more than $800 grand and go to jail for a couple of years

My Take: JP could not have this both ways. Once he decided to underreport his gross receipts to the IRS, he then had to consistently underreport for all purposes, including any sale listing. I am not making a moral call here, just observing how this works.

Once caught, there was little hope that anyone would believe him about unclaimed expenses. How credible was he at that moment? 

And why would someone go to all this effort if the end result was only $22 thousand?

What does it tell you that the IRS became aware of (a) the sale listing and (b) correlated it to gross receipts on Flanagan’s tax return? Remember: tax information is supposed to be confidential. Returns are not supposed to be laying around on someone’s desk or kitchen table. Are you telling me that someone “remembered” Flanagan’s gross receipts? Could it be that JP was already under scrutiny? The court decision does not give us background on this point, although it is this point that I find chilling. I can almost hear JP saying “how would they ever know?” I agree: how did they know?

Talking About 2014 ObamaCare Employer Taxes

I have been reviewing two ObamaCare employer taxes that are scheduled to kick-in in 2014. It’s more than a year away, but let’s say you call me and we meet for coffee. It’s a business meeting. With cheesecake.

I’ll start the conversation off:

Me:                  If an employer has enough employees, then the employer is expected to provide health benefits.

You:                 What constitutes “enough employees?”

Me:                  More than 50 full-time employees. Full-time is defined as 30 hours per week, by the way.

You:                 So if I have less than 51 full-time employees, I escape the tax?

Me:                  Yes.

You:                 What if I have more than 50?

Me:                  Depends.

You:                 On what?

Me:                  On whether any employee receives a government subsidy.

You:                 And I am supposed to know this how?

Me:                  Trust me, you’ll find out.

You:                 What if I have more than 50 employees but no one gets a subsidy?

Me:                  How did you accomplish that, Houdini?

You:                 All my employees have their insurance covered by their spouse.

Me:                  Congratulations, Harry.

You:                 What if one divorces and gets a subsidy?

Me:                  You have a problem.

You:                 What problem?

Me:                  Your penalty will be either $2,000 or $3,000, depending.

You:                 Depending on what?

Me:                  Depending on whether you offer no insurance or offer unaffordable insurance.

You:                 So if I offer no insurance it will cost me $3,000 multiplied by some number?

Me:                  No.

You:                 You are getting on my nerves.

Me:                  The penalty for not offering health insurance is $2,000.

You:                 Per employee?

Me:                  No. You get to exclude the first 30 employees.

You:                 Huh?

Me:                  I didn’t write this stuff.

You:                 Say I have 55 full-time employees. What is it going to cost me?

Me:                  (55 minus 30) times $2,000 = $50,000.    

You:                 What if I fire 5 employees?

Me:                  Then you meet the 50-employee limit and have no tax.

You:                 Seriously?

Me:                  Yep.

You:                 Even if an employee gets government subsidy?

Me:                  Did you ever work at Bain Capital?

You:                 What is this “unaffordable” insurance thing?

Me:                  If the insurance exceeds a certain percentage of the employee’s family income, then the insurance is deemed “unaffordable.”

You:                 What is that percentage, oh beacon of despair?

Me:                  9.5% of household income.

You:                 Household income, what is that?

Me:                  An easy answer would be to add the husband and wife’s income.

You:                 How am I to know the spouse’s income?

Me:                  Trust me, you’ll find out.

You:                 How?

Me:                  When the government notifies you about the subsidy.

You:                 I am really starting to dislike you.

Me:                  Hey, I’ve got feelings here.

You:                 So if I see to it that all my employee’s spouses are doctors and engineers, then I can avoid the penalty?

Me:                  You have escaped yet again, Harry.

You:                 Say that I don’t escape. What is my tax?

Me:                  Well, you get to do two calculations. You pay the lower number.

You:                 Are you charging me for this aggravation?

Me:                  Yes.

Me:                  The first calculation is to multiply every employee receiving a subsidy for your unaffordable insurance by $3,000.

You:                 Then what?

Me:                  You do the same calculation as if you offered no insurance at all.  You know, the $2,000 calculation.

You:                 Huh, what’s the difference?

Me:                  The $2,000 calculation excludes the first 30 employees. Then it is just multiplication.

Me (cont’d):    The $3,000 calculation counts only those employees receiving a subsidy.

You:                 So if I offer unaffordable insurance, but no one gets the subsidy, my tax is zero?

Me:                  I am in awe, Harry.

You:                 What if I set up two companies, with neither having more than 50 employees?

Me:                  They already thought of that angle. No go if the companies are related. You owning both makes them related.

You:                 What if I increase my portion of the insurance to, you know, keep it “affordable?”

Me:                  That would work.

You:                 I would have to reduce the actual salaries or eliminate bonuses and raises to make the numbers work.

Me:                  Were you grades too high for community organizing?

You:                 What are other companies doing?

Me:                  Depends on the company. Some companies are too large for the 50 employees to mean anything. Still… Did you hear about Darden Restaurants?

You:                 Darden is who?

Me:                  Think Red Lobster and Olive Garden.

You:                 Are you charging me by the word?

Me:                  I’ll ignore that. Anyway, according to the Orlando Sentinel the company intends to reduce its maximum schedule to 28 hours per week per employee in “selected” restaurants. They told the newspaper that this is "just one of the many things we are evaluating to help us address the cost implications healthcare reform will have on our business."

You:                 Wow, that seems harsh.

Me:                  Where do you have that money tree planted, exactly?

You:                 How does an employee get a subsidy, exactly? Is that what sets this whole thing off?

Me:                  By “whole thing” you mean “unaffordable?”                      

You:                 I am going to hit you.

Me:                  There are two conditions. We already talked about the first one: the 9.5% of household income.

You:                 You mean 9.5% of a number that I have no hope of knowing or finding out?

Me:                  Yep, that one.

You:                 Do I want to know the second one?

Me:                  If you want your head to blow off.

You:                 What…? You have to tell me now.

Me:                  The second condition is that your employee’s household income ….

You:                 Which I do not know, right?

Me:                  Right. Now continuing where I was …. Your employee’s household income must be less than 400% of the federal poverty level.

You:                 You said 400%. I thought accountants were supposed to be good with numbers.

Me:                  I am. And it’s 400%.

You:                 Seriously?

Me:                  You are way too sharp to ever be hired by CNN.

You:                 So… what is 400% for a husband and wife?

Me:                  Close to $90 grand.

You:                 $90 grand! I didn’t make that last year! Or the year before!

Me:                  Maybe you can qualify for the subsidy.

You:                 I think I am going to fire you as my CPA.