What Happens When Bush Tax Cuts Expire

The pending expiration of the Bush tax cuts at the end of 2012 is one of the most important events in taxes since they were enacted some 10 years ago. While House Speaker John A. Boehner said the House will vote on the issue this summer and the majority of our legislators believe the cuts, in general, should be extended, the general inability of Congress to act in a timely fashion should be cause for concern among taxpayers.

It's more than likely that many of the important provisions will be extended (lower tax rates; preferential treatment for long-term capital gains; etc.), but there could be important modifications that could affect many taxpayers. Congress will have to balance the fragile economy against the looming deficit. The real danger here is that the higher taxes are automatic. All Congress has to do is fail to act.

At this time it's virtually impossible to predict which provisions will be extended unchanged, which modified, and which eliminated. In this article we'll list the most important expiring provisions and attempt to provide some guidance with respect to planning.

Tax Rates

This is probably the most important provision. The current rates of 10, 15, 25, 28, 33, and 35 percent would increase in 2013 to 15, 28, 31, 36, and 39.6 percent (if the cuts expire, the 10-percent rate would be eliminated). Even low-income taxpayers would feel a significant impact. Upper-income individual taxpayers will feel a much greater impact.

The reversion to the old rates would almost surely have a severe impact on the economy. It's likely Congress will not let the reduced rates expire completely, but somewhat higher rates are possible. On a long-range basis you might want to consider accelerating income into 2012 and delaying deductions to 2013. But you've got to be careful not to overdo it for two reasons. First, the cuts may not expire and you could find yourself increasing your taxes. Second, accelerating too much income into 2012 could put you in a higher bracket than you might find yourself in in 2013.

Capital Gains and Dividends

Capital gains on individuals and other noncorporate taxpayers (gains of S corporations, LLCs, etc. are passed through and taxed to the owners) and taxed at a maximum of 15 percent (0 percent for those in the 10 or 15-percent brackets). Without extension, the rates would go to 20 percent (10 percent for taxpayers in the 15-percent bracket). In addition, gains on assets held longer than five years would be taxed at a maximum of 18 percent (8 percent for taxpayers in the 15-percent bracket).

The higher rates would apply to proceeds received in 2013 and future years. Thus, in order to insure the lower rates, the sale must be consummated and the proceeds received in 2012. You might consider accelerating installment payments to be received in 2013 and future years into 2012.

Qualifying dividends are currently taxed like capital gains, that is at no more 15 percent for individuals in the 25-percent and higher brackets (0 percent for those in the 10 or 15-percent brackets). Should the provisions not be extended, they would be taxed at ordinary income rates.

While abandoning dividend paying stocks in your portfolio makes little sense, increasing your investment in such stocks might be delayed until the law is settled. If you do business or have an interest in a regular corporation, or an S corporation with accumulated earnings and profits, you might consider a dividend before the end of the year.

Another point. The accumulated earnings tax and the tax on undistributed personal holding company income would revert to the highest individual tax rates. Paying dividends from corporate entities subject to the tax might be considered.

Phaseout of Itemized Deductions and Personal Exemption

Without extension, higher income individuals will once again face the phaseout of their personal exemptions and certain itemized deductions. (For itemized deductions, casualty, theft, wagering losses, investment interest, and medical expenses are not subject to the provision.) The phaseout of itemized deductions would begin at about $175,000; for married individuals filing joint the phaseout of personal exemptions would begin at about $260,000.

There isn't too much planning you can do here with the possible exception of accelerating charitable contributions and taxes into 2012, and even that might not be helpful because of the effect of tax payments on the alternative minimum tax.

Other Provisions Expiring

• Marriage Penalty. The Bush cuts included a provision that lessened the "marriage penalty" encountered by some couples. The impact of sunsetting of this provision would increase the burden on some taxpayers filing married, joint and reduce the standard deduction.
• Child Tax Credit. The $1,000 credit for dependents under age 17 would drop to $500.
• Child Care Credit. The child and dependent care credit would be reduced by decreasing the maximum qualifying expenses from $3,000 per child to $2,400.
• Student Loan Interest Deduction. The expiration of the current rules would mean the deduction would be phased out at lower adjusted gross income.
• American Opportunity Tax Credit. The expiration of this credit would mean that the Hope credit would once again provide the most credit for tuition deductions. But the benefits of the Hope credit can be considerably less. The maximum Hope credit per year is less than the American Opportunity Tax Credit (AOTC) and is only available for the first two years versus four years for the AOTC.
• State and Local Sales Tax Deduction. This provision allowed taxpayers to deduct either state and local sales taxes or income taxes as an itemized deduction.
• Cancellation of Mortgage Debt. This provision allowed taxpayers to exclude from income cancellation of debt income from the cancellation of a mortgage on a taxpayer's principal residence.
• Small Business Stock Gain Exclusion. Noncorporate taxpayers can exclude a percentage of the gain on the sale of qualified small business stock in a C corporation. A portion of the excluded gain is treated as a preference item for purposes of the alternative minimum tax.
• Exclusion of IRA Distributions for Charitable Contributions. This provision allows taxpayers to exclude from income distributions from an IRA that are directly contributed to a charitable organization.
• Earned Income Credit. The earned income credit benefits would be reduced on the expiration of the current provisions.

Other Points

• Alternative Minimum Tax. The current "patch" for the alternative minimum tax expires at the end of this year. It's unlikely Congress will "fix" the tax. It's expected to legislate another patch with an increased exemption amount.
• Additional Medicare Tax. Beginning in 2013 high income taxpayers ($250,000 for married, filing joint; $200,000 for others), will face an additional medicare tax of 0.9 percent on renumeration and self-employment income.
• Medicare Tax on Unearned Income. Beginning in 2013, the law imposes a Medicare contribution tax on unearned income of 3.8 percent. Unearned income includes interest, dividends, annuities, royalties, rents, and capital gains. The tax applies to a taxpayer whose modified adjusted gross income is in excess of $250,000 (married filing joint; $200,000 for other filers except married, separate).
• Higher Threshold for Medical Expenses. Currently, only the amount of medical expenses in excess of 7.5 percent of a taxpayer's AGI (adjusted gross income) is deductible. Beginning in 2013, that percentage increases to 10 percent.
• Estate and Gift Taxes. The more liberal estate and gift tax rules expire at the end of 2013. We won't go into detail here, but, unless the current provision is extended, these taxes will go back up to much earlier levels.

Tax Planning

It's probably too early take any concrete steps, but you should be aware of the problem and know what plan of action you're going to follow when the fate of the law becomes clear. For example, you might want to look for ways to accelerate income into 2012, even if you wait till the end of the year to do so. And, if you were planning to sell some investment acreage in the next few years, you might want to put it on the market now to get the process started.

Many tax planning moves here are tricky. Unfortunately, most computer tax programs won't be of much help at this point. Professional help is strongly advised.

To implement a Strategy (big tax savings) you need TIME!  It is not something you can do AFTER the year ends.  Once the year is over you have lost the opportunity.  The earlier you implement... the bigger the tax savings. Call us TODAY at 954-591-8290 to get started.

K.R. Hoffman & Co., LLC, counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. Discover how we can help you overcome your tax and business challenges. For more information or to become a client, call me at (954) 591-8290 TODAY or drop me a note.

Tax Returns of the Rich and Famous

America's first billionaire, John D. Rockefeller, once said that "if your only goal is to become rich, you'll never achieve it." But some of us still manage to achieve it, and the rest of us want to know how. Since 1992, the IRS Statistics of Income Division has issued an annual report examining The 400 Individual Tax Returns Reporting the Largest Adjusted Gross Incomes. I know what you're thinking -- the IRS "Statistics of Income" division is where fun goes to die. But read on -- there's some pretty interesting stuff buried in this year's 13-page report.

• What does it take to join the club? Well, for 2009, you had to report $77.4 million in adjusted gross income. Now, that may sound like a lot. But it's actually down from $109.7 million in 2008, and down even further from the $138.8 record high in 2007. Of course, $77.4 million just gets you in. The 400 earners averaged $202.4 million. (If that sounds like a lot, it's actually down from a staggering high of $334.8 million in 2007.)
• How do the top 400 make their money? Probably not how you imagine. Just 8.6% of it came from salaries and wages. 6.6% came from taxable interest; 13.0% came from taxable dividends; and 19.9% came from partnerships and S corporations. Once again, capital gains made up the biggest share of the top 400's income. For 2009, it was 45.8%, or $92.6 million each. In fact, the top 400 individuals reported 16% of the entire country's capital gains! However, that amount was significantly down from 2008, when the top 400 averaged $153.7 million in gains. Clearly, the 2008 economy and stock market crash took a toll on the super-rich as well as the rest of us.
• What do they actually pay? 2009's top 400 averaged $170.3 million in taxable income and paid $40.9 million in tax. That makes their average tax rate 19.9% -- up from the 18.1% they paid in 2008. Why the higher rate? Remember, most of their income consists of capital gains, taxed at a maximum of 15%. When the percentage of their income consisting of capital gains goes down, their average rate goes up.

On average, the top 400 are a generous group. 387 of them reported charitable contributions, with the average deduction weighing in at $16.4 million. The top 400 as a whole claimed 4.0% of the nation's total charitable deductions, down from 5.2% in 2008. (You've got to wonder what goes wrong in 13 people's lives that let them earn tens or hundreds of millions of dollars without deducting a dime for charitable gifts. Maybe they just want to "give" more to Uncle Sam!)

3,869 taxpayers have appeared in the top 400 list since the IRS started tracking them in 1992. But just 27% have appeared more than once. And only 2% have appeared 10 or more times. It's worth noting that some of today's highest-profile earners fall short of this group. Billionaire Warren Buffett, who inspired the "Buffett Rule" that would tax million-dollar incomes at a minimum 30%, reported earning "just" $62.9 million in 2011. He probably won't make the cutoff. Republican presidential candidate Mitt Romney reported earning $20.7 million in 2010 and $20.9 million in 2011. As rich as that sounds, he's nowhere near the top 400.

We realize you may find these numbers comical. Who makes $200 million in a single year? But someday when your business catches fire and lands you in the top 400, you'll get pretty heated at the thought of paying $40 million in tax. That's when you'll be glad we gave you a proactive plan for paying less tax. Don't forget us when you make the big time!

K.R. Hoffman & Co., LLC, counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. Discover how we can help you overcome your tax and business challenges. For more information or to become a client, call me at (954) 591-8290 TODAY or drop me a note.

A Big Ouch

The English novelist and playwright Henry Fielding once wrote that "a rich man without charity is a rogue; and perhaps it would be no difficult matter to prove that he is also a fool." But sometimes you can be rich, charitable,and foolish, all at the same time. And that can make for some really expensive mistakes. 

Joseph Mohamed is a California real estate broker and appraiser who's made a fortune buying, selling, and developing real estate. In 1998, he and his wife Shirley set up a charitable remainder trust for the benefit of the Shriners Hospitals for Children, the Sacramento Food Bank & Family Services, and the Pacific Legal Foundation. Then, in 2003 and 2004, he donated six California properties to the trust: four adjacent street corners in Rio Linda, a 40-acre subdivided parcel south of Sacramento, and a shopping center in Elk Grove. 

Mohamed prepared his own taxes for those two years -- definitely not standard operating procedure for someone in his shoes. When it came time to fill out Form 8283, "Noncash Charitable Contributions", he skipped the instructions because "it seemed so clear that he didn't think he needed to." The form said the description of the donated property could be "completed by the taxpayer and/or appraiser." And Mohamed was an appraiser, right? Of course he knew what his own properties were worth. How hard could it really be? He attached statements to his returns explaining how he valued the two biggest parcels. Then he deducted $18.5 million for the gift, satisfied that he had done all he needed to substantiate his writeoff. 

It turns out, though, that the IRS wants a teensy bit more than just your say-so before handing out eighteen million in benefits. In fact, they have some pretty specific rules for deducting any gift of property worth more than $5,000. You need a "qualified" appraisal, made no sooner than 60 days before the gift and no later than the due date of the return reporting the gift itself. It has to be signed by a certified appraiser -- not the donor or the taxpayer claiming the deduction. And the appraisal has to include specific information about the property itself, your basis in the property, and how you acquired it in the first place. 

The IRS started auditing Mohamed's 2003 return in April, 2005. You can probably imagine how charitably inclined they were toward his self-appraisal. So Mohamed went out and got independent appraisals showing the properties were worth over $20 million -- two million more than he deducted. And the trust actually sold the 40 acres south of Sacramento for $23 million. You would think that would be enough. But you would be wrong. The IRS held firm, and the case wound up in Tax Court. 

Last month, the Court issued their 26-page opinion inMohamed v. Commissioner. They ruled that none of Mohamed's appraisals were "qualified" under Section 1.170A-13(c)(3)(i) and shot down his entire deduction. The Court confessed that "We recognize that this result is harsh -- complete denial of charitable deductions to a couple that did not overvalue, and may well have undervalued, their contributions -- all reported on forms that even to the Court's eyes seemed likely to mislead someone who didn't read the instructions." But, the Court continued, "the problems of misvalued property are so great that Congress was quite specific about what the charitably inclined have to do to defend their deductions, and we cannot in a single sympathetic case undermine those rules." 

So, ouch. Big, big ouch. (Insert expletive here.) Eighteenmillion bucks worth of deductions, lost because someone didn't dot the i's and cross the t's. Six million in actual tax savings, down the proverbial drain. We realize it sounds self-serving to tell you to come to us before you make a big financial move. But Joseph Mohamed's case emphasizes how important this really is. You may not have millions riding on doing it right. But are you really willing to risk tax benefits you truly deserve by doing it yourself?

K.R. Hoffman & Co., LLC, helps Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, businesses and finances. Discover how we can help you with your tax and business challenges. For more information or to become a client, call me at (954) 591-8290 or drop me a note.

Time to Start Planning for Next Year's Taxes

This year's tax deadline may have come and gone already but it's never to early to start planning for next year. With that in mind, here are eight things you can do now to make next April 15 easier.

1. Adjust your withholding. Why wait another year for a big refund? Now is a good time to review your withholding and make adjustments for next year, especially if you'd prefer more money in each paycheck this year. If you owed at tax time, perhaps you'd like next year's tax payment to be smaller.

Give us a call (954.591.8290) if you need assistance in adjusting your withholding.

2. Store your return in a safe place. Put your 2011 tax return and supporting documents somewhere secure so you'll know exactly where to find them if you receive an IRS notice and need to refer to your return. If it is easy to find, you can also use it as a helpful guide for next year's return.

3. Organize your recordkeeping. Establish a central location where everyone in your household can put tax-related records all year long. Anything from a shoebox to a file cabinet works. Just be consistent to avoid a scramble for misplaced mileage logs or charity receipts come tax time.

4. Review your paycheck. Make sure your employer is properly withholding and reporting retirement account contributions, health insurance payments, charitable payroll deductions and other items. These payroll adjustments can make a big difference on your bottom line. Fixing an error in your paycheck now gets you back on track before it becomes a huge hassle.

5. Consult a tax professional early. If you are planning to use a tax professional to help you strategize, plan and make financial decisions throughout the year, then contact us now. You'll have more time when you're not up against a deadline or anxious for your refund.

6. Prepare to itemize deductions. If your expenses typically fall just below the amount to make itemizing advantageous, a bit of planning to bundle deductions into 2012 may pay off. An early or extra mortgage payment, pre-deadline property tax payments, planned donations or strategically paid medical bills could equal some tax savings. If you need help with tax planning for 2012 give us a call. We can help you prepare an approach that works best for you.

7. Strategize tuition payments. The American Opportunity Tax Credit, which offsets higher education expenses, is set to expire after 2012. It may be beneficial to pay 2013 tuition in 2012 to take full advantage of this tax credit, up to $2,500, before it expires.

Each household's financial circumstances are different so it's important to fully consider your specific situation and goals before making large financial decisions.

Feel free to contact us (954.591.8290) any time you have questions or concerns. We can help you stay abreast of tax law changes throughout the year--not just at tax time.

Something to Scream About

It's one of the most recognizable images in all of art. It's Norwegian artist Edvard Munch's iconic vision The Scream: an agonized figure --little more than a garbed skull and hands -- set against a background of blood-colored sky. And last month, it sold for a record-setting price. But could it have been inspired, at least in part, by his tax return?

Munch grew up in Oslo, son of a dour priest. At 16, he enrolled in college to become an engineer. He did well, but he quickly dropped out, disappointing his father, to study painting, which he saw as an attempt "to explain life and its meaning" to himself. At 18, he enrolled at the Royal School of Art and Design of Christiana, where he began painting portraits. His personal style addressed psychological themes and incorporated elements of naturalism, impressionism, and symbolism. He wound up studying in Paris and exhibiting in Berlin before painting the first of four versions of The Scream in 1893.

In 1908, Munch suffered a brief breakdown, followed by a recovery. That recovery brightened Munch's art as well as his life, as his later work becoming more colorful and less pessimistic. He finally gained the public approval he had sought for so long; he was made a Knight of the Royal Order of St. Olav; and he hosted his first American exhibit. Munch spent the last years of his life painting quietly and alone on a farm just outside Oslo. Today, he appears on Norway's 1,000 kroner note, set against a background inspired by his work.

We remember Munch now for his art, not his life. But that life included some frustrating run-ins with the tax man. Apparently, Munch wasn't any happier keeping timely and accurate records than the rest of us. Here's part of a letter that his biographer, Sue Prideaux, quotes him as writing, in her book Edvard Munch: Behind the Scream:

"This tax problem has made a bookkeeper of me too. I'm really not supposed to paint, I guess. Instead, I'm supposed to sit here and scribble figures in a book. If the figures don't balance I'll be put in prison. I don't care about money. All I want to do with the limited time I have left is to use it to paint a few pictures in peace and quiet. By now, I've learned a good deal about painting and ought to be able to contribute my best. The country might benefit from giving me time to paint. But does anyone care?"

Even without that tortured face in The Scream, most of us can still probably relate to his frustration!

Last month, Sotheby's auction house in New York sold a pastel-on-board version of The Scream that Munch painted in 1895 for $119.9 million -- a new record for art sold at auction. The seller was Norwegian billionaire Petter Olsen; the buyer remains unknown. If the seller had been American, there could have been quite a tax to pay. "Capital gains" from the sale of appreciated property held more than 12 months are ordinarily capped at 15%. (Republican presidential candidate Mitt Romney has proposed eliminating tax on capital gains for taxpayers earning under $200,000; while President Obama has proposed raising them to 20% for taxpayers earning over $250,000.) But paintings like The Scream are classed as "collectibles" and subject to a top tax of 28%. (You would be disappointed if we didn't say that's enough to make a collector scream!)

Are you holding precious artwork or antiques that are just taking up space in your house? Call us before you call the auctioneer. We'll make sure you keep as much of your record-setting price as possible. And remember, we're here for your family, friends, and colleagues, too!

K.R. Hoffman & Co., LLC, helps individuals and businesses take control of their taxes. Discover how we can help you with your business and tax challenges; call me at (954) 591-8290 or drop me a note.

Minister Housing Allowance

Ministers must qualify to exclude a housing allowance from taxable income. Under Code Section 107 of the Internal Revenue Code, a minister who satisfies all conditions contained in Section 107 may exclude from taxable income the qualifying amount of housing allowance. While many ministers are familiar with the concept, they frequently forget the detailed terms and conditions associated with this benefit.

Only qualified ministers may receive housing allowance. The IRS reserves this benefit for ordained, licensed, or commissioned ministers of the gospel who received their credentials from a church. Generally, specialized ministerial licenses do not qualify for a housing allowance.

In addition, the minister must be performing the duties of a minister during his work time. The Internal Revenue Regulations generally define the duties of a minister. The duties of a minister employed by a church generally include leading a worship service, performing sacerdotal functions, and managing the church or some significant segment of the church. A different test applies when the minister works outside the church.

Few churches use the term sacerdotal to describe a minister’s duties. The term sacerdotal originally arose within the Roman Catholic faith to describe those duties performed by the priests. Today, most churches define sacerdotal to include those duties normally expected of a minister by that church. Certainly, sacerdotal duties include performing weddings and funerals. But it also includes prayer, Bible study, preaching, teaching, counseling, leading church services, visiting the sick and infirm, and spreading the gospel through various means and media.

Once the individual is duly qualified as a minister and is performing ministerial duties, then the mechanical parts of the housing allowance must be performed. First, out of the minister’s total compensation, the church is responsible for designating in writing an amount as a housing allowance. This amount can range up to 100 percent of the minister’s compensation. The board or compensation committee should annually pass a resolution setting a fixed dollar amount of each minister’s housing allowance. The board or compensation committee may adjust the housing allowance during the year, but the adjustment will only apply prospectively. If the church provides a parsonage for the minister, the church is responsible for setting the fair rental value of the parsonage as furnished, plus utilities, and providing that information to the minister.

Second, the minister must track all cash expenses related to owning, occupying, or maintaining his primary residence. The minister will need to retain receipts should the IRS question his housing allowance. We urge all minsiters and clergy to keep a separate checkbook to keep track of their housing allowance and expenses.

Finally, the minister must determine the fair rental value of his home as furnished, plus utilities. The minister should not use a real estate professional associated with the church where he is serving.

The minister may exclude from taxable income the lowest of the amount designated by the church, the amount spent by the minister owning, occupying, and/or maintaining his primary home, or the fair rental value of the home as furnished, plus utilities.

As a side note, the housing allowance is taxable for self-employment taxes unless the minister has elected out of Social Security.

If you have any questions about this topic, tax law changes, have questions about the IRS and your church, or want to become a client, please call us at 954-591-8290 or use our Contact form.

Report Card Time

Memorial Day has come and gone, and the school year is quickly winding down, if it isn't already over. Kids are getting excited for summer vacay, and there's just one hurdle left -- the dreaded report card. (If your kids are getting nervous and antsy around mail time, you might want to pay attention!)

 Kids in school aren't the only ones who have to sweat report-card time. That's right, the IRS gets a report-card time, too. In fact, they get two. By law, National Taxpayer Advocate Nina Olson has to submit two reports to Congress each year: the "Objectives Report," which outlines goals and activities planned for the coming year, and the "Annual Report," which summarizes the 20 most serious problems encountered by taxpayers, recommendations for solving those problems, and other IRS efforts to improve "customer" service and reduce taxpayer burden.

 And how do you think our friends at the IRS are doing? Well, this year's Annual Report listed twenty-two problems, not 20. Their biggest conclusion is that the IRS is simply "not adequately funded to serve taxpayers and collect taxes." It identifies "the combination of the IRS's expanding workload and declining resources as the most serious problem facing taxpayers."

 Granted, the IRS faces an especially tough challenge. "There were approximately 4,430 changes to the tax code from 2001 through 2010, an average of more than one a day, including an estimated 579 changes in 2010 alone. The IRS must explain each new provision to taxpayers, write computer code so it can process returns affected by the provision, and train its auditors to identify improper claims."

 And there were more specific problems, too. The IRS has to rely on computers to do most of their work, and computers don't always get things right. The IRS adjusts about 15 million returns per year -- but treats only 10% of those as "audits," so taxpayers don't always get traditional audit protections. And sometimes the IRS is just too busy to respond: they answer just 70% of taxpayer phone calls, and just 53% of written correspondence gets answered in 45 days. It's hard to ace your report card when you're missing that much of your homework!

 What can the IRS do about their report card? Well, they can't just make up their missing credit in summer school. But the Taxpayer Advocate does have two main recommendations. First, she urges Congress to "develop new budget procedures designed to fund the IRS at a level that will enable it to meet taxpayer needs and maximize tax compliance." And second, she suggests codifying a "Taxpayer Bill of Rights" to clearly outline and explain taxpayer protections and and responsibilities.

 Fortunately, the news isn't all bad -- the IRS has joined the social media revolution! There's a smartphone app to help track your refund, a YouTube channel with helpful videos in English, American Sign Language, and various foreign languages, and podcasts you can download from the iTunes store. You can even follow them on Facebook and Twitter!

 Our "Plan A," of course, is to give you the concepts and strategies to help you pay the least amount of tax legally possible -- then help prepare returns that avoid IRS scrutiny. But just in case that scrutiny finds you, we're always ready with "Plan B" -- to help deal with the IRS on your behalf, and make sure you don't become another Annual Report statistic!

 If you have any questions about this topic, tax law changes, have questions about your business, or want to become a client, please call us at 954-591-8290 or use our Contact form.

Proper Recordkeeping and Tax Deductions Go Hand in Hand

Recordkeeping is critical to securing a deduction. In Gabriel S. Garcia et ux. (T.C. Memo. 2012-139) the taxpayer operated two businesses that provided services to other entities.

The taxpayer paid various workers wages or contract labor expenses. Some of the payments were made by check and some of the payments were in cash. The taxpayer did not maintain complete books and records of the wages or contract labor payments he made during 2007 or 2008. Some, but not all, of the payments were reported to the IRS and to the workers as wages, and some were reported as nonemployee compensation.

Some, but not all, of the workers reported the income received from the taxpayer on their tax returns. Some of the workers provided to the taxpayer incorrect or illegible Social Security numbers. For 2007, the taxpayers reported on their tax return $356,581 as wage and contract labor expenses. The taxpayer was able to substantiate wage and contract labor expenses of only $230,291.

The IRS allowed a deduction $230,291 for 2007. For 2008, the taxpayers reported on their tax return $283,613 as wage and contract labor expenses but could substantiate expenses of only $157,190. The IRS allowed a deduction $157,190 for 2008.

The taxpayers' returns were prepared by his brother, who was not an accountant. The returns claimed erroneous, overstated or unsubstantiated deductions other than the ones for wages or contract labor. While the taxpayer testified he paid the amounts claimed, his testimony was not corroborated by any witnesses and he could not explain how he derived the amounts deducted on his tax returns in the absence of records, and his brother, who prepared the returns, did not testify.

The Court noted the taxpayer did not have any time records or other evidence from which we could estimate the amounts that he paid without substantiating documents. He did not identify any sources for cash payments to workers. The Court noted that it could have made an estimate of the expenses, but noted it could do so only when the taxpayer provides evidence sufficient to establish a rational basis upon which the estimate can be made. Without such evidence, the Court would not make an estimate. It allowed no more than the IRS allowed.

If you have any questions about this topic, tax law changes, have questions about your business, or want to become a client, please call us at 954-591-8290 or use our Contact form.

De-Friending Uncle Sam

Last week, Facebook's initial public offering hit the market like tickets to the season's hottest concert. Shares opened at $38, unlocking billions in new wealth for founders and early investors. While shares have actually fallen below that IPO level, investors will probably "like" Facebook for quite some time!

Taxes played a lead role in Facebook's IPO. The company went public largely so founder Mark Zuckerberg could pay $2 billion in taxes to exercise options on 120 millionshares. And six insiders, including Zuckerberg, have set up annuity trusts most likely intended to minimize gift and estate taxes on transfers to future heirs. (In Zuckerberg's case, those future heirs haven't even been born -- how'sthat for advance planning!) But one Facebook founder has taken an even more drastic step to avoid tax -- he's actuallyrenounced his American citizenship!

Eduardo Saverin was born in Brazil in 1982. His wealthy father moved the family to Miami in 1993 to avoid kidnapping threats, and Saverin became a U.S. citizen in 1998. He met Zuckerberg while the two were students at Harvard and, using his family's wealth, became Facebook's first investor. But Saverin was squeezed out shortly thereafter, reportedly at the urging of more experienced backers. He sued Zuckerberg, and settled out of court for what appears to be something between 2% and 4% of the company -- worth as much as $4 billion at last week's market close. 

Now, Americans like Saverin who give up their citizenship do pay an "exit tax" on the value of appreciated assets as of the time they leave. That means, essentially, you're taxed as if you sold everything the day before you surrender your U.S. passport. You'll file Form 8854 to calculate and report your tax. If you can't afford to pay on the spot, you can even "finance" it as long as you post adequate security. 

In Saverin's case, that means he pays based on the pre-IPO value when he left in September -- but he avoids tax on any appreciation after that date. This could spell hundreds of millions in savings. And where has Saverin settled? Singapore, where he has lived since 2009, and where the tax on capital gains is zero. Zip. Zilch. Nada. The Wall Street Journal reports that Saverin has become a Kardashian-like figure in his new home: "Mr. Saverin is regularly spotted lounging with models and wealthy friends at local night clubs, racking up tens of thousands of dollars in bar tabs by ordering bottles of Cristal Champagne and Belvedere vodka, according to people present on these occasions. He drives a Bentley, his friends say, wears expensive jackets and lives in one of Singapore's priciest penthouse apartments." 

Saverin is hardly the first American to to de-friend Uncle Sam. The IRS publishes a quarterly list of Americans who leave, one that totaled 1,781 in 2011. And, while Saverin denies he left to avoid taxes, outrage has grown over his move. Senators Chuck Schumer (D-NY) and Bob Casey (D-PA) have even introduced legislation that would punish future Saverins -- their so-called "Ex-Patriot Act" ("Expatriation Prevention by Abolishing Tax-Related Incentives for Offshore Tenancy") would impose a 30% tax on future expatriates' gains after they leave our shores. 

Are you working to create the next Facebook? There are lots of ways to pay less tax when you eventually sell, and they don't require you to give up your citizenship! So call us when you're ready for your IPO -- and remember, we're here for the rest of your social network, too!

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form.

Thou Shalt Not Sin?

It's no secret that Washington uses the tax code to do more than just raise revenue. Lawmakers also use it to influence some of our biggest financial decisions, with tax deductions for mortgage interest to encourage homeownership, tax credits for fuel-efficient cars to encourage conservation, and "bonus depreciation" to stimulate business spending. Washington seems to believe those incentives really work. And cynics argue that the real reason we'll never see a true flat tax is because lawmakers are loath to give up the power to regulate that comes with their power to tax.

Government also uses the tax code to sway some of our smaller decisions, too. This is especially true with so-called "sin taxes" -- essentially, fees we pay to consume unhealthy products or engage in unhealthy behaviors. As Adam Smith wrote in The Wealth of Nations, "sugar, rum and tobacco are commodities which are nowhere necessaries of life, which are become objects of universal consumption, and which are therefore extremely proper subjects of taxation."

230 years later, sugar, rum, and tobacco are still taxed. (In New York City, a pack of smokes comes with a hefty $6.86 in federal, state, and local taxes -- the tobacco is extra!) The 2010 health care reform slapped a 10% tax on tanning beds. Public health advocates have proposed taxes on fatty foods and sugary sodas to fight obesity. And many Americans, discouraged by what they see as a decades-long failure in the War on Drugs, call for legalizing drugs, taxing them to shift profits from private cartels, and using the revenue to fund anti-addiction efforts.

So, how effective are sin taxes at balancing their dual goals of raising revenue and discouraging unhealthy behavior? Well, federal and state tobacco taxes alone raise nearly $30 billion per year. They seem to do that job just fine. But some economists find that sin taxes send the wrong message by legitimizing the behavior they try to discourage. Here's what Harvard Professor Michael J. Sandel says in his new book, What Money Can't Buy: The Moral Limits of Markets:

"A study of some child-care centers in Israel shows how this can happen. The centers faced a familiar problem: parents came late to pick up their children. A teacher had to stay with the children until the tardy parents arrived. To solve this problem, the centers imposed a fine for late pickups. What do you suppose happened? Late pickups actually increased."

Clearly, telling parents "don't be late or we'll fine you" sends a very different message than telling them simply "don't be late." And so it goes with sin taxes, too. Telling smokers and drinkers "don't indulge or we'll tax you" offers them implicit forgiveness -- that it's actually OK to light up and enjoy two-for-one Happy Hour so long as they pay the fee. (If you're reading these words with a cigarette in one hand and a Red Bull in the other, you can breathe a sigh of relief!) It may sound hypocritical for Uncle Sam to wag his finger at you with one hand while he reaches into your pocket with the other. But sin taxes have been around a lot longer than income taxes, and they aren't going away.

 There's really no "planning" we can help you do to avoid sin taxes. (We would just give you the same advice as your mother.) But it may be worth it, next time you pay any tax, to ask yourself "what's the government trying to accomplish with this tax? What's the government trying to get me to do?" Understanding why you pay a tax can make you a better-informed consumer. And that, in turn, helps all your dollars go farther.

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form.