Federal Income Tax Increases Throughout U.S. History

With all the attention being given to Obama’s health care reform campaign, and Congress’ bill that includes a hefty tax increase to pay for it, I began thinking about tax rates and increases throughout American history. To put the pending tax rate changes into perspective for all of my readers, I have put together the following outline of tax increases in U.S. history.

The Revenue Act of 1916

Nearly a hundred years ago, one of the earliest major tax increases in America was under the Revenue Act of 1916. Prior to the act, only 2% of citizens paid income taxes, and those who did have to pay only paid a mere 1-5%. In order to pay for war expenses, and stabilize the U.S. economy, the new act raised the lowest tax rates by 1%, and the top tax rate by a staggering 15%. However, these increases were not exclusive to income taxes, as rates levied on businesses and estates were also raised. Although experts at the time predicted these taxes would be enough, the First World War quickly became more costly than expected.

The War Revenue Act

Just one year later, in 1917 the properly named War Revenue Act increased taxes yet again. As part of the act, the cutoff for the U.S.’s highest income tax rate went from $1.5 million to only $40,000. Keep in mind that this was “1917” dollars, and citizens making $40,000 per year would be considered wealthy by today’s standards. Only a few months after the War Revenue Act passed, another act was passed to collect additional revenue from taxpayers. All in all, personal income taxes reportedly paid for over a third of all the Word War I related expenses the U.S. incurred.

The Great Depression

As we all know, the 1920’s were a great time in America. The economy was great, tax rates were low, and Federal revenue was flowing. That is until the stock market crash of 1929, which triggered the start of the great depression. Between 1932 and 1936, taxes were increased several times to support economic recovery. By 1937 the lowest income tax rate in the country was 4% and the highest was an astounding 79%. Comparatively, the highest 2009 tax Federal income tax rate is only 35%.

The "Victory" Tax

Often referred to as the biggest tax increase in more than 20 years, the US Revenue Act of 1942 – also known as the "victory" tax – was more than just one little tax increase. Although it's name may lead you to think the act was meant to bump the economy, the money was actually used to prepare for World War II.

Another reason this particular act was so upsetting to many was because up until it passed, only about 5% of Americans had to pay Federal income taxes. However after it was enacted, the act raised the percentage of Americans paying income taxes to 75%. In addition to raising income taxes, the act also increased corporate tax rates by nearly 10%, decreased personal exemptions from $1,500 to $1,200, and decreased dependent exemptions from $400 to $350.

The Revenue Act of 1951

Only 9 years after the last large tax increase bill, the Revenue Act of 1951 was introduced to generate even more Federal revenue. However, although both personal and corporate tax rates were raised by as much as 5%, the government’s total tax revenue actually dropped in the years following the Revenue Act of 1951.

The Tax Equity and Fiscal Responsibility Act of 1982

In 1981, the Economy Recovery Act became law and contained some of the biggest tax cuts of modern American history. However, just a year later, Congress passed the Tax Equity and Fiscal Responsibility Act, which raised the federal unemployment base wage and the FUTA tax rate. The act also setup new excise taxes on airports, airways, telephones and cigarettes. Finally, the act also reduced the limit on tax-free contributions to defined-contribution pension plans by $15,475, and reduced limits on benefits from a defined-benefit plan from $136,425 to $90,000.

The Omnibus Budget Reconciliation Act of 1993

Signed into law by President Bill Clinton, the highly controversial Omnibus Budget Reconciliation Act of 1993 drastically increased personal income tax rates. Just three years prior, the Omnibus Budget Reconciliation Act of 1990 had increased the top U.S. income tax rate to 31%, but under the new act it was further increased to 39.6%. Corporate tax rates also increased to 35%.

Expiration of the “Bush Tax Cuts”

Although they have not expired yet, in 2001 and 2003 Congress passed significant income tax cuts that became known as the “Bush Tax Cuts.” The acts reduced the top Federal income tax rate to 35%. However, both Congress and the Obama administration have vowed to let these cuts expire next year, which will result in a nearly 5% increase for taxpayers in the top tax bracket.

Tax Friendly Ways to Save for your Children’s Education

Yesterday, the Roni Deutch Tax Center Tax Help Blog posted a new entry discussing the best tax friendly ways to save for your children education. In this economy, it may seem almost impossible to try saving money for the future, but as you will see there are dozens of ways to plan for your child’s future regardless of your income.

Are you already worried about trying to save for your children’s future education related expenses? In today’s economy, millions of taxpayers are struggling to pay their bills let alone save up for future bills. It may seem overwhelming to be thinking about a day when you will have to help your child earn their diploma, but by preparing early you can avoid expensive loans twenty years down the road.

It is a common misconception that only very wealthy families can save for their children’s future. In fact, there are multiple educational savings plans that were made especially for middle-class and low-income households. To help those of you looking to get a head start on the process, please enjoy the following article on tax friendly ways to save for your children's education.

1. Coverdell Education Savings Account

If you are looking for a way to avoid taxes and fees when you withdrawal your child's education money in the future, then a Coverdell Education Savings Account (ESA) is the way to go. It allows you to contribute $2,000 per year until the beneficiary is 18 years of age. Although the contributions are not tax-deductible, the distribution cash will become tax-free when withdrawn in the future. However, the funds must be used only for school expenses. For more information on opening a Coverdell ESA check out this page on IRS.gov.

Continue reading this blog entry, here.

Do You Owe the IRS?

For those of you who do not know, I recently became a contributing author to WomenEntrepreneur.com. My first article on how to know if you owe the IRS was published on Friday, and you can check out some of the article below, with the remainder here.

Entrepreneurs have a lot in common: drive, ambition, creativity and--many times--tax debt. Tax laws are complicated for everyone, and doubly so for enterprising business owners. There are countless ways to get in trouble. But don't panic--there are also several ways to get out of trouble and resolve your tax debt.

The longer you wait to resolve a debt, the more interest and penalties the IRS will tack on. So even if you don't have the money to fully pay your tax bill, you need to take action. Call the IRS and find out the full extent of the debt. Don't be afraid to check the math and question the totals. Simple mistakes on a tax return can result in big tax bills.

Once you've verified that your tax debt is legitimate, and you agree on the amount owed, it's time to consider your options. The option you select depends on your financial situation.

1. Fully pay. This may seem obvious, but the easiest way to resolve an IRS debt is simply to pay it in full. Consider selling a rarely used car or recreational vehicle in order to satisfy the IRS. While this is inconvenient and unpleasant, consider the alternative: IRS collections hounding you day and night, putting liens and levies on everything you own. Doing without a luxury item sounds a lot more appealing, don't you think?

2. Offer in compromise. If you can't pay off your entire tax debt, you might qualify for an offer in compromise (resolving the entire debt for less than is owed). Why would the IRS accept less than what is owed? Well, think of it the way a business owner might: Collection activities cost money. If you can get a lump-sum payment for as much as you can ever hope to collect, even if it's less than the total, there is a benefit in cutting your losses. While this is an excellent way to resolve a tax debt without destroying your finances, it is very difficult to qualify.

My Open Letter Pleading the IRS to Update Their Expense Standards

Last week I sent an open letter to Henry M. Paulson, Jr., Secretary of the U.S. Treasury Department seeking changes to the Internal Revenue Service’s allowable standards policies. Their current practice of using outdated allowable standards, refusing to update those standards, and failing to accommodate in the face of clear and convincing evidence to the contrary is making the tax relief process unnecessarily difficult for taxpayers seeking IRS settlement.

The IRS has numerous relief programs available to help taxpayers that find them selves with large back tax liabilities. These programs, such as the Offer in Compromise or Installment Agreement, allow taxpayers to resolve their debt without having to pay down the entire amount at once. But when negotiate with the IRS you must complete a detailed financial analysis, which usually requires the help of a professional.

The financial analysis compares your gross monthly income with monthly allowable expenses to determine what, if any, payments you can reasonable afford. These allowable expenses do not include all monthly expenses, but only include expenses that the IRS deems necessary. The IRS sets these maximum allowable expenses include limits for food, housekeeping, clothing, personal care, entertainment, housing, utilities, vehicle, and vehicle operating expenses. A person’s household size, income, and geographical location all have an effect in determining each individual’s allowable amounts.

Unfortunately, the IRS calculates the allowable expenses for any given calendar year using statistical data gathered two years prior. Therefore, in any given year, the IRS uses two-year-old data to determine a taxpayer’s current and future allowable expenses, which in my opinion is flawed in the first place. Consider how much has the price of milk gone up over the past two years, constantly rising cost of gasoline. Using outdated statistics is unacceptable and I strongly suggest the IRS revisit the idea of this practice in the first place.

Then, as if using two-year-old data wasn’t bad enough, the IRS chose not to update its allowable expenses for 2007 whatsoever. The IRS is using statistical data from 2004 to determine the maximum amount taxpayers can claim as expenses in 2007, which is 100% unacceptable in my opinion. The IRS needs to update these requirements, which is why I have drafted a letter pleading that the IRS immediately update their allowable standards. Using three-year-old data to calculate a person’s allowable expenses is like kicking a taxpayer when they are down. This data needs to be updated.

With the letter I would also like to suggest that the U.S. Treasury Department reprimand the IRS Automated Collection Service Unit for its refusal to deviate from the allowable standards even in the face of strong evidence to support it. When a taxpayer can demonstrate that they are living within the average of their community, and the allowable standard is no longer reflective of that average, then the IRS employee must deviate to the taxpayer-requested amount. Failure to do so is in complete contradiction to the IRS’ own Internal Revenue Manual, which states, "National [and] local expense standards are guidelines. If it is determined a standard amount is inadequate to provide for a specific taxpayer's basic living expenses, allow a deviation."

In addition to drafting the letter, and sending it to various influential members of the government, my firm has also put out a press release on the issue, see Roni Deutch Sends Open Letter Urging the IRS to Update the Allowable Standards for Living Expenses. Hopefully my letter, and the issue in general, receives enough attention to convince the IRS to update their old standards.

Tax Penalties of Foreclosures

As everyone in the country knows, the real estate and mortgage industry has been in trouble over the past few years. Thousands of families find themselves in financial trouble due to drastic rate increases in adjustable rate or interest only mortgages. Most people failed to consider the possibility of the huge increases upon entering the agreements. Only now, they find themselves with mortgage payments that they cannot afford to pay. Often, foreclosure is the only option available to these struggling families. However, there is one important aspect of a foreclosure that people forget – the resulting tax liability.

Foreclosure is always the last resort for someone struggling to make mortgage payments. People usually think it will be the end of their problems. However, the IRS considers debt canceled through foreclosure to be part of a taxpayer’s income. The IRS feels that it is entitled to the appropriate income taxes on that money. It also has access to every taxpayer’s financial information so it can ensure the appropriate taxes are paid. And as most of the country already knows, the IRS is very aggressive in collecting taxes that they know are outstanding and feel they deserve.

Forecasts indicate that over 20% of the loans made sine 2005 to people with weak credit using interest only or sub prime loans will end in foreclosure. Typically, these loans require little or no down payment and begin with extremely low payments that quickly rise with rate adjustments. Due to paying so little toward the principal amount and the lowering value of homes across the nation, people are increasingly finding themselves upside down in debt with huge mortgage payments.

"The tax laws are far too complex for borrowers to understand," claims Kurt Eggert, a professor at Chapman University Law School. "There are distinctions between selling a house for less than the loan amount and losing the house in foreclosure. It is crucial to get expert tax advice to sort through the bewildering complications. The whole concept can be counterintuitive – your home has declined in value and you lose it. Then the IRS says you owe tens of thousands in taxes because you got a windfall when the debt was forgiven."

Foreclosures are not the only way to end up with this type of tax liability though. The other is when a homeowner sells his or her house for less than the value of the mortgage and the bank will just forgive the difference. In those situations the homeowners is technically supposed to report that amount as income. This is known as a "1099 shortfall" which is an IRS policy that treats forgiven debts as income, even if a taxpayer has nothing to show for it.

So many people across the country are finding themselves in serious financial trouble. Lenders encouraged hundreds to refinance their houses for more than the home's fair-market-value. This was the case with Agnes Mouser. She is a 65-year-old widow who was hoping to pay off her credit card debt by taking out money with a refinance. "A real nice young man came out to see me," Mouser noted. "He could have been my grandson." The appraiser her bank sent out valued her mobile home at $43,500 in 2000 by using two new standard homes as benchmarks for calculating the value. The bank then agreed to let her borrow $34,730 against the value of her house. She paid the bank over $2,500 in closing costs and her loan carried an interest rate of nearly 15%.

When Mouser realized she could not meet her monthly payments in 2003, she contacted a lawyer who informed her that the county valued her home at less then half of what the bank had – only $19,970. Fortunately for Mouser, her bank forgave the difference. Unfortunately, the IRS did not. Soon thereafter, Mouser got a tax bill for over $10,000.

Thousands of taxpayers across the country are facing massive IRS tax liabilities with little chance of relief. With all the attention this issue is getting, Congress is finally beginning to consider legislation to help lower the burden on these people who are facing such huge financial problems. Senator Debbie Stabenow and Senator George Voinovich sponsored a bill to eliminate the federal rule that considers mortgage relief taxable income. The White House has already indicated support for Stabenow’s bill and President Bush claimed he hopes to include Stabenow’s ideas in his home ownership relief initiative. However, before a bill can go to the White House, Congress must approve it. Currently, no progress has been made on Stabenow’s bill, which has been sitting in Congress since May.

Sources:
http://www.lsj.com/apps/pbcs.dll/article?AID=/20070911/OPINION01/709110311/1085/opinion
http://jalopnik.com/cars/frankfurt-auto-show/frankfurt-auto-show-bmw-x6-activehybrid-concepts-298085.php
http://www.signonsandiego.com/uniontrib/20070821/news_1b21taxes.html

New Law Could Drastically Raise Taxes On Multinational Corporations

Pressure is growing in Washington to force a tax on foreign companies with subsidiaries in the United States who move funds back to their parent countries that have more favorable tax rates. These businesses currently pay next to nothing in taxes. In response, the United States House of Representatives has already voted to increase tax rates to as much as 30%. However, business groups are saying the measure could deter firms from investing in the United States. Multiple lobby groups state that about 60 multinational companies have already expressed concern about the proposal, which is likely to be considered by the United States Senate some time next month.

Democrats in Congress are regarding the proposal, known as the Doggett law, as a legitimate crackdown on cooperate tax avoidance. They are hoping the tax could raise an estimated $7 billion per year.

The goal of the proposal is to stop multinational corporations from going "treaty shopping" to find countries with more friendly tax laws. If approved by the Senate, the proposal could see firms paying a tax of up to 30% on interest payments and other capital flows between US operating countries and their parent businesses. This tax would be enforced even if the funds were being transferred to affiliates in the United Kingdom and the Netherlands. This would disrupt a historically tax fee practice that was based upon existing "tax-free" treaties between the United States and these countries. Yet, experts claim that firms based in countries without treaties such as South Korea and Singapore would be hit even harder by the new tax.

The new tax was added as an amendment to a farm appropriations bill drafted earlier this year by a Texas congressman. The practice of adding new legislation as an amendment to another popular bill is common in Congress as a way of negotiating the approval of a law. When making such an amendment to a popular bill members of Congress can dramatically improve their chances of getting a controversial new law passed.

However, numerous Republicans fighting in the Democrat controlled Congress have said the proposals flew in the face of existing treaties with other countries, and were based on a misconceived idea that equates tax avoidance with seeking to find a competitive tax position. "These companies are not doing anything illegal," claims Rhian Chilcott, director of a lobbyist group in Washington. "They are taking advantage of a tax treaty that the United States negotiated years ago." He went on to explain that many local subsidiaries are already paying taxes and would effectively be taxed twice on their income.

However, the Democrats who support the law are emphasizing that the law will be specifically focused on preventing tax havens that are used to hide earning. They claim the goal of the law is not to target legitimate companies that are paying their taxes. Rather it will attempt to gain revenue from companies abusing the treaties to pay little or no taxes on their income. Many massive multinational corporations setup offices in locations that have tax-free treaties with the United States for the sole purpose of avoiding tax liabilities.

For example, if the legislation passed, Samsung’s South Korean conglomerate would not be eligible to make tax-free transfers from it’s United States division to it’s United Kingdom financing unit. Currently the company pays a zero tax rate on such transfers because of the Anglo-American treaty. Samsung’s United States subsidiary would instead be forced to pay the 15-cent tax rate that applies to all Korean companies on transfers from the United States. Unfortunately, no representative from Samsung would comment on the new law.

The measure would also dramatically hit Japanese carmakers with large United States operations. Nissan is one automaker that would likely see increased taxes as a result of the legislation. Several international companies are currently lobbying against the legislation including Panasonic, Unilever, Alcatel-Lucent, Swiss Re, and Allianz. An executive from an undisclosed global corporation said, "this is another signal that the United States is not a friendly place to do business. We do not need this. We can go to Canada or Mexico."

IRS to Begin Increasing Amount of Audits

Because of increasing pressure from Congress and the Executive Branch, the IRS has began an effort the drastically increase the number of audits they perform to help lower the ever growing tax gap. Eliminating the tax gap – estimated to be $312 billion to $353 per year – would provide enough money for the federal government to pay for Medicaid’s entire 2007 budget. Montana Senator Max Baucus, the top tax writer in Congress, has publicly demanded the IRS conduct more audits in order to continue to help lower the tax gap.

As a result, the IRS has announced that it plans to do more random audits in the next few years than it has in the past. In addition, the IRS announced plans to conduct more audits of high-risk groups. The Government Accountability Office recently concluded a detailed study on the tax gap and informed the IRS on which high-risk groups have the highest percent of misreporting on their tax returns.

With help from congress, The Government Accountability Office has identified the following groups of taxpayers to have the highest rates of misreporting on their tax returns:

• Sole proprietors reporting on Schedule C forms
• S corporations where owners aren’t taking enough wages in an effort to minimize payroll taxes
• Taxpayers who gamble and underreport their winnings
• Taxpayers who own a farm or are involved in farming
• Taxpayers who take advantage of the Earned Income Tax Credit when they don’t qualify
• Taxpayers who incorrectly report capital gains from sales of investments
• Taxpayers who take itemized deductions on Schedule A for medical expenses, charitable contributions, and non-reimbursed job expenses

However, being in one of these groups does not mean a taxpayer will necessarily be audited. Based on 2005 statistics, a taxpayer’s average likelihood of being audited was around 1%. But if a taxpayer falls into one of the groups listed above their likely hood of being audited increases to above 5%.

The IRS had discontinued its random audit process five years ago in an effort to be seen as a kinder and gentler agency of the government. However, under pressure to increase revenue to offset the tax gap, the IRS has decided to once again target not only returns that raise red flags, but to also select taxpayers to audit at random. Beginning in October, it’s expected that the IRS will target approximately 50,000 income tax returns from 2006. The IRS is warning that not all taxpayers audited will be subject to a scrupulous line by line audit though. Out of the 50,000 returns the IRS aims to audit, they estimate that 8,000 will just be examined by the IRS requiring no action on the part of the taxpayer, and 9,000 of the taxpayers audited will be able to respond to audit inquiries via mail. The remaining 30,000 taxpayers will be required to make face-to-face meetings though. Many of these audits are to be conducted even if the IRS doesn’t suspect a problem, but the IRS is claiming they hope to use the audits to gather information about taxpayer norms.

Shortly after the IRS’s announcement of their plan to increase audits, National Taxpayer Advocate Nina E. Olson delivered a report to Congress identifying the priority issues the Office of the Taxpayer Advocate will address in the coming year. One important aspect of the report was the battle the IRS is facing because of all the pressure being placed on them to lower the tax gap quickly.

"For fiscal year 2008, both the IRS and the Taxpayer Advocate Service (TAS) face similar challenges," Olson claimed. "The IRS is under scrutiny for its efforts to close the tax gap, while TAS is struggling to address taxpayer difficulties that arise as a result of these very efforts."

In multiple prior reports to Congress, Olson has identified the tax gap as one of the most serious challenges in tax administration. She has put together numerous proposals to try and help address it, but nothing has come from her proposals. She has expressed concern that the pressure on the IRS to reduce the tax gap could result in the IRS excessively cutting corners in it’s treatment of taxpayers. She emphasized that Congress needs to play an important role in helping to achieve an appropriate balance.

"IRS oversight should not just be limited to urging the IRS to collect more tax revenue," Olson continued. "Even as Congress directs the IRS to address specific areas of noncompliance, Congress should require the IRS to adopt a long-term research strategy that focuses not only on "closing the tax gap" but also on understanding what it takes to encourage taxpayers to be voluntarily compliant and how to change taxpayer behavior."

Sources
IRS to start auditing more tax returns?
Congress Instructs IRS to Conduct More Audits
More Audits Are Coming; How Can You Cope?
IRS targeting certain deductions in effort to close tax gap
They're back! IRS resurrects random audits

New Name and Layout

As you have probably already noticed we recently unveiled a new layout for my blog. We also purchased a new name for the blog, which you can now access by typing in RonisBlog.com. In addition to the physical changes we will also be making some changes to the content we feature on my blog. As well as the regular tax news I will also be posting franchise news and special featured articles which will go more in debt into tax law issues. So remember to update your bookmarks with http://ronisblog.com and be sure and check back daily for updates.