Wednesday, December 30, 2009

Nightmare on Pennsylvania Ave

I’ve been beating on the State of California a bit (it’s so easy) so I thought I would switch topics to our friends in Congress.

In 2001, Congress enacted estate tax reform which provided that the estate (aka inheritance) tax would expire Jan 1, 2010 for one year only. I wrote about this topic in an earlier piece and opined that Congress would “fix” the sunset provision by now and likely settle the amount that a decedent could pass tax free to heirs at $3.5 million. In what has been labeled by some as “congressional malpractice”, the Senate failed to take up important tax legislation that had to be done by year end. As a result several expiring tax breaks including tuition deductions, R&D credits, charitable donations from IRA’s and the estate tax were not addressed.

So now, we have a situation where people who pass away after Thursday will not have their estates taxed at all, but those passing away today will. There are credible reports of families with wealthy members on life support waiting until Friday to pull the plugs, solely for tax purposes. When you figure it could be huge amounts of money in the balance, it seems likely that this is true.

Not going to affect me you say? Don’t be so sure. One of the principles built into tax law is that of a stepped up basis for inherited property. Many people benefit from this provision, particularly surviving spouses, who may ultimately sell highly appreciated assets they receive by way of inheritance. It enables an heir to escape paying taxes on historical gains on inherited property. As part of this new change, we now have a formula to determine basis starting with historical cost. This means that if you sell the family home inherited from your grandparents, your tax cost may be what Gramps paid for the place. Just imagine the nightmare trying to determine historical basis for property bought decades ago by someone who is no longer around! Tax professionals across the nation are cringing at this accounting nightmare, and heirs will end up paying far more in taxes on capital gains as a result.

It is unclear whether any fixes can or will be attempted retroactively. If so, they will likely be challenged in court. We will just have to wait and see what, if anything, our legislators do to fix this mess when they return from their holiday recess.

Tuesday, December 29, 2009

Are you kidding me?

In the “Are you kidding me?” department, yesterday I wrote about the Use Tax reporting requirements we are supposed to comply with. Recently the BOE has provided more guidance on sales taxes collected by different districts within California and how to handle it.

Because of voted indebtedness, different areas within California have different sales tax rates. Example: South Gate’s combined rate is 10.75%, while Huntington Beach has a rate of only 8.75%. Question: What happens if someone who lives in South Gate goes shopping in Huntington Beach? Do they pocket the savings?

Not according to Sacramento. If you buy goods subject to sales tax and do not pay at least the amount that would have been assessed in the district of your residence, you are supposed to remit the difference with a letter, or form BOE-401-DS, to the BOE. (Refunds are not allowed.)

Heaven forbid that South Gate miss out on that extra $4 for the $200 TV set you bought last year.

I’d like to see a survey showing how many of our State legislators have ever paid this tax. I’d be willing to bet that the result would be zero! Unfortunately neither immateriality nor inability of enforcement will stop a state agency from promulgating rules for the rest of us to follow.

Monday, December 28, 2009

Beware the BOE!

Here in California, as in most states, we have a sales tax. Because of Constitutional restrictions on states, and also as a practical matter, California and the other states are unable to levy sales taxes on inbound sales from out of state retailers that do not have physical locations within the state. As a result many people shop online or via mail order and avoid paying sales taxes.

There is a move afoot in Congress to relax these rules and make a uniform approach to sales tax so that states can assess these transactions. So far it has not progressed much because politicians are currently reluctant to raise taxes so close to an interim election.

California has its own unique take on this. Since California cannot tax the interstate sale, if an out of state seller sells something to you and California sales taxes were not paid on the transaction, California will tax you on the in state “use” of the item. The tax is the same rate as the sales tax that would have been paid had it been taxable for sales tax purposes. This Use Tax is supposed to be voluntarily paid to the Board of Equalization by adding it to your income taxes and paying on April 15th. Compliance has rarely been enforced, and as a result NOBODY DOES IT.

The BOE has decided to start cracking down on all you scofflaws living here, but they do not have the resources to chase after pennies. So now, tax preparers will be compelled to ask you about out of state purchases in order to include them on your tax return! If we do not, and you are audited, we could be subject to liabilities as well. As miniscule and as silly as it seems, look for your tax preparer to begin asking you about all your on line purchase transactions in order to calculate your Use Tax.

Thursday, December 24, 2009

Stay Tuned....

as I write this new post its Thursday morning and here at O&S we are still working on getting the last few tax projections done for our clients who need them before year end. Its been a hectic couple of weeks, and I have not had a chance to compose anything interesting for the Blog.

But wait till next week! I have a couple of topics that will be of interest to business owners about a little known tax perk and some big changes in sales taxes that will affect all Californians, unfortunately.

Hope you all have a Merry Christmas and a safe holiday season.


Monday, December 7, 2009

‘Tis the Season

It’s the Holiday Season already. I can tell because two annual-as-clockwork events have started occurring i.e. (1) Its finally raining in Southern California and (2) my mailbox is plugged with solicitations from charities. This time of year charities recognize the more generous holiday spirit of potential donors, as well as the looming December cutoff for tax deductible donations by the more tax aware amongst us. Either way, the radio and direct mail advertising ramps up exponentially. One area that our office sees a lot of misunderstanding about is donations of property, notably AUTOS.

For donations of property you are generally entitled to deduct the fair market value of property given to a qualified charity. So when you donate a car, boat, RV or whatever to charity, you are entitled to take as a tax deduction the value of that property. The way this worked in the past was you would contact one of those radio advertisers, they would come and pick up your car, and you would take a deduction, say a hypothetical $4900 (coincidentally not exceeding the $5,000 appraisal requirement) for the clunker towed out of your driveway. Assuming a combined tax bracket of 30%, that $4900 deduction would net you a tax reduction of around $1500. Taxpayers diligently documented the values of these cars by way of Kelley Blue Book, Edmunds or some other resource. They got a reduction in tax, the charity got cash, the company that picked up and sold the car took a commission, and everyone was happy.

Well, almost everyone. Unfortunately, IRS figured out that some of these values might be slightly overstated. Enter the new rules: Now, when certain assets (Cars, Trucks, Boats, RV’s) are donated to a charity and the charity sells them, the charity, or their agent, is required to disclose to the donor the proceeds from the sale. This will be your deduction. Since most of these assets are immediately disposed of via auction, it effectively limits your deduction to the rock bottom wholesale price. The only way around this is if the charity actually keeps the car, truck, or whatever and uses it in its exempt purpose.

So, when you hear the radio spots asking you to donate your car, before you call remember that the tax deduction will get you less than 1/3 of what you would realize if you were to sell that car yourself. If you sell the car you could still donate the wholesale amount to your favorite charity, get the same tax deduction, and pocket the difference!

Wednesday, December 2, 2009

A Real Boob Job

In an effort to locate funding sources for the health care bill currently working its way through the Senate, Congress has actually proposed to create a new tax on elective cosmetic surgeries. The proposal would tax these cosmetic surgeries at a rate of 5%.

The argument is that cosmetic surgeries, including Bo-tox, liposuction, tummy tucks, etc are a luxury of the wealthy, and who better to afford to help with health care funding but the rich? We keep hearing this same song from politicians, but here in So Cal, cosmetic enhancements are almost a requirement for high school graduation, not just the domain of the wealthy. This tax will reach a lot of people, yet it probably won’t find too many outside the medical profession willing to stand up and protest. How many Hollywood stars would come to a rally against taxing nose jobs?

The issue actually raises some interesting questions, like will doctors now be required to collect the tax and remit it to IRS on a regular basis? Will your physician be the one who determines how much of a surgery relates to elective cosmetics versus reconstruction? How will an IRS agent determine if that boob job was reconstructive or elective? Will an audit require before and after photos? What if it was reconstructive as a result of illness or an accident, but the new version was somewhat enhanced? Would there be a partial tax? If so, how would they measure it, by cup size? I can just see a taxpayer arguing this issue with a bureaucrat... "No, I’m really not that big, see?" (zip…)

This new tax will undoubtedly have unintended consequences. Canadians who travel to the US for their medical treatment may now be forced to go to Mexico to save money, taking their medical treatment dollars with them. The poor in the US will claim a disadvantage as they may be priced out of the market, and will demand a government subsidy. This scheme could well cost more than it generates, and then what comes next, taxing tattoos?

As you can see I'm having way too much fun with this. My next posting will be serious, I promise.

Monday, November 30, 2009

Throw Grandma under the bus?

For those of you who haven’t been following this stuff, Federal tax law as currently written provides for an inheritance tax on decedent’s estates that exceed $3.5 mil. Currently if you die with a net worth over that amount, your estate (actually your heirs) will be taxed at a 45% rate on the excess value.

That is scheduled to change January 1, 2010. For one year only, the inheritance tax is scheduled to go away for decedents dying between January 1, 2010 and December 31, 2010. After that, the “death tax” as it’s fondly referred to, is scheduled to return with a smaller exemption amount of $1mil in 2011 and a higher tax rate of 55%. This has given rise to some speculation that there may be an increase in accidental deaths of wealthy seniors beginning next year! The word is that many oldsters have been drafting plans to disappear on extended vacations and otherwise avoid contact with relatives for about a year. Sort of like what deer do during hunting season.

But before you start planning scuba and sky diving lessons for Grandma, be forewarned that the House is scheduled to reevaluate this issue starting next week. The Senate should follow shortly. There are good reasons both pro and con as to whether or not we should tax estates, but I think the easy explanation is that our leaders do not want to appear as if they are trying to cut a tax break for the wealthy and their heirs. I expect that they will extend the current rules for at least a year, possibly indefinitely.

Heaven forbid somebody should pass away and escape taxation as a last act of defiance…

Tuesday, November 24, 2009

Please define the term “Voluntary”

The IRS just announced new proposed regulations that will explain how to implement a new tax code section that requires credit card, debit card, and third party payments such as Paypal to be reported to IRS starting in 2011. Institutions will be required to disclose amounts paid to recipients. What this means is that when you pay a bill or buy something over the internet with a credit or debit card, the bank clearing the transaction will tell IRS how much was received by the payee.

The reason for this rule, as announced in the IRS press release, is “to improve voluntary tax compliance by business taxpayers and help IRS determine whether their tax returns are correct and complete”.

It seems that Congress thinks some of you business owners haven’t been quite as "voluntary" as you should be…

So, if you run a business and accept credit card, debit card, or Paypal type payments, IRS will be looking to match up your reported gross receipts with what will be reported to them by the banks. Since this data by itself will be worthless for the purpose of trying to match up with total reported gross receipts, look for another round of reporting requirements on businesses that will eventually require all businesses to separately state on tax returns how much they received via electronic payments and how much they received via cash and checks. And woe be to the small business that doesn’t get it to agree with the bank’s records! Helloooo audit!

The good news: It will take the government years to figure out that the program is ineffective without additional reporting requirements. Since this is starting in 2011 it will be some time before it affects anyone other than the reporting institutions.

The bad news: Someone will have to pay for all the accounting and reporting costs. Guess who that will be?

Monday, November 16, 2009

One time chance to put $20k into a Roth?

Usually I don’t like to use words like “tax loophole” or “tax shelter”, but their exists right now a situation where the sun, moon, and Internal Revenue Code have aligned perfectly to create an opportunity to create a permanent tax shelter by way of Roth IRA account(s). See if this applies to you:

Currently many people are precluded from contributing to a Roth IRA because of income limits or they are covered by another plan. Further, regular IRA conversions to a Roth IRA have also been restricted to people below certain income levels. The restrictions on conversions lapse on 12/31/2009. Anyone will be able to convert an existing IRA account to a Roth IRA account in 2010.

So here’s what you might do: Make a NONDEDUCTIBLE IRA contribution of $5,000 for 2009 to a traditional IRA (not a Roth) account before December 31. In January, convert the $5,000 traditional (nondeductible) IRA to a Roth, and make a nondeductible $5,000 Roth contribution for 2010 at the same time. Keeping score? You now have $10,000 in a Roth account. More good news: Your spouse can do the same thing. If you do, you could sock away $20k between the two of you in a matter of weeks and set it aside to grow completely tax free! If you are over 50, the annual limit is $6,000.

But there are caveats. The conversion will be a taxable event, so any gain on the traditional to Roth conversion will create a tax. In my hypothetical scenario a few days appreciation may not amount to anything. Also this assumes you do not already have existing IRA accounts. If you do, the first $5,000 contributions in my example will be aggregated with the value of all your IRA’s and you may not want to do the conversion piece of this plan. Also, the income limits for Roth contributions are still in place, so you may not be able to do the extra $5k in January depending on your income and marital status. As always, you MUST run your specific scenario past a tax professional who can run the numbers and determine if this works for you. The rules are complex. Don’t trust this one to the brother-in-law with turbotax!

Now, where can I find $20K?

Tuesday, November 10, 2009

Welcome to California. Now lend us money!

Just last week you may have felt the presence of Arnold and the State legislature rummaging around in your wallet. Effective Nov 1 withholding rates and estimated tax payment requirements increased by 10%. This is not a tax increase they tell us, only a temporary loan from us to them for tax monies that the state will ultimately have to refund to you.

Hopefully they will actually refund the excess taxes they are taking, instead of issuing a warrant that the banks will not honor, or simply parking on your refund for an extra month or so, both of which FTB has done recently. Better still, you will be earning a whopping 0% (that’s zero) rate of interest on your “loan” to the state. So, not only are you now a lender, but you aren’t making any money at it either. Does this qualify all of us as failing banks? Perhaps Federal bailout money will soon follow…

Here’s what you need to do to limit the damage. First, be sure you pay in JUST ENOUGH tax to be penalty proof under the rules, regardless of what you may owe in April. This 10% increase is actually voluntary, and you can adjust your withholding to have the correct amount taken out of your paycheck. Second, after you have penalty proofed yourself, STOP. Arrange your taxes so that you owe the state in April, not the other way around. This will limit your exposure to getting a warrant or waiting for a delayed refund to arrive. Note that this new increased withholding level is set to continue indefinitely.

This strategy may have Federal tax consequences, so before embarking on it you should contact us or do the math to see if it works for you.

Sidebar: The LA Times reports that the very same elected officials that brought us to this point because of their inability to balance the budget or live within their means are currently trying to exempt themselves from pay cuts that they implemented for all state employees. I’d be OK with that if we had the ability to reduce their pay to zero under a pay-for-performance plan.

Wednesday, November 4, 2009

Your Tax dollars at work

You should all be familiar with the new tax incentive available for first time home buyers that is set to expire this November 30. The incentive provides for up to an $8,000 tax credit, (that’s real money), for qualifying first time home buyers, and was intended to stimulate the real estate market.

Recently the IRS came out and said that they had uncovered a significant amount of fraud by those claiming the credit (I’m shocked, absolutely shocked!). In one case the credit was claimed by a four year old who allegedly had bought his first home…what an enterprising young tyke! Before long we will probably see him on cable TV doing infomercials on how to buy real estate with nothing down and money from the government. Helps him pay for his pampers….In response the IRS has announced that they will be approaching an audit rate of nearly 100% on tax returns claiming this credit.

Faced with reports of fraud and abuse, what does Congress do? Expand the program, of course! Yup, the Senate is expected to pass a bill this week to extend the credit into 2010 and expand it to more people beyond first time home buyers.

I’d have a punch line inserted here but I don’t think its necessary

Wednesday, October 14, 2009

The Tax Man Cometh

Recently I went fishing on a charter boat out of San Diego. The bite was heating up and Yellowfin Tuna were flying over the rail faster and faster as guys would hook up and yell for the gaff. It was one of those great trips. Then all of a sudden someone said ‘Hey look at this, there’s a shark !”. Sure enough, a Mako shark was chewing on the tuna the guy had brought to the boat. The crew was quick to respond and gaffed what was left of the tuna, but it was too late. The comments that went around the boat were: “The tax mans is here”, “lost one to the tax man” and “gotta pay the tax man”.

So, being the tax geek that I am, some questions immediately popped into my mind: Since we were fishing off the coast of Mexico would the shark be an international tax man? Either way he sure took a bite out of my friend’s day. Maybe my friend should have made a waters edge election…or opened an offshore account? Perhaps the boat should have negotiated a tax treaty with Mexican sharks?

Okay, no more dumb accountant jokes. I guess the point of this ramble is to point out that taxes are always a part of success. Smart people accept that fact and manage the tax burden, not ignore it. Our goal is to keep the pain to a minimum.

Friday, October 2, 2009

You never call anymore....

Recently I heard this from a fishing buddy who was teasing me since we hadn’t spoken in at least a week. He wanted to rub in a story about great trout fishing at a lake in Montana that he was enjoying while I was here at the office (aren’t cell phones wonderful?).

While I was reviewing a client’s individual tax return I was struck by the same thought. Here I could see some missed tax planning opportunities and wasted tax deductions that a little advance work could have helped save, yet I hadn’t heard from this person until well after the end of the year, too late to do anything about it. I called her and explained the situation so that she would not repeat the same mistakes in 2009, and she said that she wished she had had some guidance last year. My response was: Why didn’t you call?

When CPA’s get established and build a good following of loyal clients, it becomes impossible to anticipate everyone’s tax situation without some help from the client. It’s sort of like expecting my doctor to call me and tell me when I’m sick. If I don’t call him and schedule a checkup, or tell him I’m not feeling well, how would he know? We all tend to get in the same mode of making our payments, funding the IRA, send the tax papers to the CPA, etc. etc., and often forget that laws and personal financial situations change during the year and maybe we need to reevaluate things in order to reduce the tax you pay.

So, even if you don’t feel like your tax situation is out of control, it might be wise to make a call for a checkup. Before the end of the year, while we can still have an impact on your tax burden.