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.

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.

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.

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.

Paul

‘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!

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.