What Would be the Biggest Tax Mistake This Year?

Earlier in the week the Freakonomics blog on NYTimes.com posted an opinion piece on the largest tax mistakes that could be made this year. With the looming expiration of the Bush tax cuts, and changes to capital gains rates on the horizon new tax laws are inevitable. Author Stephen J. Dunber asked a hand full of "smart people" what would be the biggest potential tax policy mistake? You can find a few of the responses below courtesy of the Tax Prof, or click here for the full article.

William G. Gale (co-director, Urban-Brookings Tax Policy Center): "Policy makers have already made the biggest potential tax policy mistake they could have made this year. Ever since the tax cuts were enacted in 2001 and 2003, policy makers have known the law would expire at the end of 2010. That “drop dead” date offered an auspicious way to galvanize a systematic effort to reform a tax system that is badly in need of repair. Instead, policy makers pretty much ignored the issue until just before the 2010 Congressional recess, when politically tinged efforts to extend some or all of the tax cuts finally began — a “debate” that was too little, too narrow, and too late."

Donald Marron (director, Urban Brookings Tax Policy Center): "With little time left on the legislative clock, policymakers will be hard-pressed to top the tax policy blunders they’ve already made this year. Most notable is their failure to decide what this year’s tax law should be. While politicians, analysts and the media endlessly debate how expiring tax cuts might affect taxpayers in 2011, the real disgrace is that we still don’t know what the tax law is in 2010."

Joel Slemrod (professor of economics and public policy, University of Michigan): "The biggest possible mistake would be to lose sight of the long-term issues that surround tax policy. Given the depth of the recent recession as well as the slow pace and apparent fragility of the expansion, it is appropriate that the macroeconomic effect of tax policy changes be taken seriously. A big jump in the tax level could abort the delicate recovery."

Clint Stretch (managing principal for tax policy, Deloitte Tax): "The biggest potential tax policy mistake for this year is the mistake of inaction. Individuals deserve a prompt resolution of a host of issues that make thoughtful tax compliance and planning difficult and, worse, invite costly mistakes. The fate of the Bush tax cuts should be addressed as soon as possible. A rush of mid-December tax-planning transactions is not desirable. An increase in withholding on middle class taxpayers in January could be harmful. Congress should address the extension of the patch for the alternative minimum tax to provide certainty for the nearly 25 million Americans. Taxpayers with large estates should be able to plan with reasonable certainty about the rules."

5 Tax Law Changes you MUST Know About

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Top Lawmaker Wants Mileage-Based Tax On Vehicles

From the Associated Press:

A House committee chairman said Tuesday that he wants Congress to enact a mileage-based tax on cars and trucks to pay for highway programs now rather than wait years to test the idea.

Rep. James Oberstar, D-Minn., said he believes the technology exists to implement a mileage tax. He said he sees no point in waiting years for the results of pilot programs since such a tax system is inevitable as federal gasoline tax revenues decline.

"Why do we need a pilot program? Why don't we just phase it in?" said Oberstar, the House Transportation and Infrastructure Committee chairman. Oberstar is drafting a six-year transportation bill to fund highway and transit programs that is expected to total around a half trillion dollars.

A congressionally mandated commission on transportation financing alternatives recommended switching to a vehicle-miles traveled tax, but estimated it would take a decade to put a national system in place.

"I think it can be done in far less than that, maybe two years," Oberstar said at a House hearing. He was responding to testimony by Rep. Earl Blumenauer, D-Ore., who recommended that the transportation bill include pilot programs in every state to test the viability of a mileage-based tax.

Blumenauer said public acceptance, not technology, is the main obstacle to a mileage-based tax.

Pilot programs "would be able to increase public awareness and comfort and it would hasten the day we could make the transition," Blumenauer said.

Oberstar shrugged off that concern.

"I'm at a point of impatience with more studies," Oberstar said. He suggested that Rep. Peter DeFazio, D-Ore., chairman of the highways and transit subcommittee, set up a meeting of transportation experts and members of Congress to figure out how it could be done.

The tax would entail equipping vehicles with GPS technology to determine how many miles a car has been driven and whether on interstate highways or secondary roads. The devices would also calculate the amount of tax owed.

"At this point there are a lot of things that are under consideration and there is also a strong need to find revenue," Oberstar spokesman Jim Berard said. "A vehicle miles-traveled tax is a logical complement, and perhaps a future replacement, for fuel taxes."

Gas tax revenues — the primary source of federal funding for highway programs — have dropped dramatically in the last two years, first because gas prices were high and later because of the economic downturn. They are forecast to continue going down as drivers switch to fuel-efficient and alternative fuel vehicles.

Transportation Secretary Ray LaHood has ruled out raising gas taxes to make up for the funding shortfall, and the White House has rejected a mileage-based tax. They have not offered an alternative.

White House Leans Toward Tighter Enforcement of Taxes

From The Wall Street Journal:

President Barack Obama's initiative to raise new tax revenue to pay for major policy changes likely will focus in the short run on tightening enforcement against businesses and wealthy individuals. In the long run, some experts believe it could lead to sweeping changes in the tax code itself.

White House officials disclosed the tax initiative on Tuesday, saying they intend to explore ways to better enforce the current code as well as improve it by eliminating corporate subsidies and untangling its many complexities. Mr. Obama has assigned the task to his President's Economic Recovery Advisory Board, an outside panel of economists and businessmen headed by former Federal Reserve Chairman Paul Volcker.

Administration officials said the group faces two limitations: no tax increases before 2011 and no tax increases on families earning less than $250,000 a year. The task force is to report its recommendations by Dec. 4.

The initiative reflects the Obama administration's re-evaluation of how the U.S. government pays for itself, as lawmakers drop some major proposals from Mr. Obama's budget plans for future years.

A growing number of experts and many lawmakers believe the current U.S. income-tax system isn't raising enough money because it is obsolete. They say the U.S. should consider switching to more efficient means of raising revenue -- for example, taxes on consumption.

"We're shooting ourselves in the foot economically by relying as heavily as we do on income taxes when the rest of the world relies on consumption taxes," said Michael Graetz, a Yale University professor and former Treasury official in President George H.W. Bush's administration. "I think you can tinker with the existing system, but anybody who believes they are going to get enough revenue simply by improving collection of taxes owed is fooling themselves."

IRS eases tax rules on US firms with foreign units

From the Associated Press:

The Internal Revenue Service, seeking to make cash more available during the current credit crunch, has issued a rule making it easier for U.S. corporations to bring home money made by their foreign subsidiaries.

The IRS temporarily expanded a 1988 ruling allowing corporations to borrow money held by foreign subsidiaries without having to pay the 35 percent corporate income tax.

"We were recognizing that there were liquidity restraints for companies" during the current credit crisis, Treasury Department spokesman Andrew DeSouza said Tuesday. He said the action would make it easier for foreign subsidiaries to provide loans to their domestic parents.

The current rule allows a company's foreign units to make a tax-free loan to the company as long as it is repaid in 30 days. Over a one-year period, the company can have outstanding loans from its subsidiaries for up to 60 days.

The temporary rule change would allow the U.S. company to keep cash from a single loan for up to 60 days. In total, the company could have borrowed money for up to 180 days in a one-year period.

To avoid being subject to taxation, the money would have to be paid back and could not be used as distributions such as dividends.

Congress, as part of tax legislation passed in 2004, enacted a similar break giving corporations a one-time deduction of 85 percent on dividends received from foreign subsidiaries. That act, aimed at encouraging domestic investment, lowered the effective tax on qualifying dividends from 35 percent to 5.25 percent.

The IRS said in a recent report that 843 corporations took advantage of the deduction. It said that $312 billion in repatriated dividends qualified for the deduction, creating a total deduction of $265 billion.

IRS Taxes Personal Calls On Work Cell Phones

Almost everyone has a cell phone these days. But if you're among the people who make personal calls on a company mobile phone, the Internal Revenue Service may want to talk with you.

As previously mentioned – and quoted here – in the LA Times, the IRS puts cell phones in the listed property category — right along with company-issued motor vehicles and use of the corporate plane. And they consider little perks like cell phone calls from your work BlackBerry to be taxable as an extension of your compensation package. So either you or your employer is supposed to pay up.

The law for taxing cell phones was written 20 years ago, when the wireless industry was in its infancy and mobile phones were about the size and weight of a brick. Back in the day, if you wanted one of those big Motorolas with the 2-foot antenna (visualize Michael Douglas on the beach in the 1987 movie Wall Street), you — or more likely, your company — would have shelled out about $4,000. So of course, they were reserved for top-level executives.

Fast-forward 20 years, and now everybody has cell phones. They're smaller, lighter and faster. Instead of just calling on them, you can watch the news, listen to music and scan your e-mail. The CEO, the IT guy and the facilities manager each have one. Doctors and reporters would be lost without them. And how else would that real estate agent know whether you've blown her off or you're stuck — again — on the freeway en route to meeting her?

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 Clarifies: New Rule Will Not Punish Teachers

The IRS recently put out a release to clear up some ongoing confusion about the effects of a recent law change to the IRS’s deferred-compensation rules. They reassured teachers and other school employees that new deferred-compensation rules will not affect the way their pay is taxed during the upcoming school year. Under the law teachers and other employees are given an annualization election – meaning they are allowed to choose between being paid only during the school year and being paid over a 12-month period. Therefore if they choose the 12-month period, they are deferring part of their income from one year to the next. However, the IRS clarified that the new rules will not be applied to annualization elections for school years beginning before Jan. 1, 2008, so school districts and teachers will have time to make any changes that are needed.

New Tax Law Changes

On May 25th 2007, President Bush signed into law H.R. 2206 – the "U.S. Troop Readiness, Veterans’ Care, Katrina Recovery, and Iraq Accountability Appropriations Act, 2007." The bill included a $120 billion emergency war supplemental funding bill for the current wars in Iraq and Afghanistan as well as numerous tax related law changes. Among the numerous provisions contained in H.R. 2206 are the "Fair Minimum Wage Act of 2007," and the "Small Business and Work Opportunity Tax Act of 2007" – a $4.84 billion small business tax relief package. Below are brief summaries of the important tax law changes.

IRS Liability Notices
The new law increases the time from 18 to 36 months in which the IRS has to notify individuals about a tax liability before interest and penalties are enforced. Therefore the IRS must cease charging interest and filing related penalties on a taxpayer’s liability if the IRS fails to notify the taxpayer about a liability within 36 months after the taxpayer filed the return.

Tax Return Preparer Penalties
This provision broadens and toughens tax return preparer penalties for returns prepared next year. It expands the scope of the penalty to include all types of tax returns and increases the penalty for irresponsible tax return preparation to a $1,000.00 fine or 50% of the income derived by the tax preparer for preparing the claim.

Levies to Collect Federal Employment Tax
The act provides that the rules requiring notice and a hearing opportunity before the IRS can issue a levy do not apply to disqualified employment tax levies, which are any levies to collect employment taxes for any period if the taxpayer requested a hearing for unpaid employment taxes.

Erroneous Refund Claims
The new law adopts a new penalty for filling erroneous refund claims and applies to all claims filed for the 2007 tax year. The act establishes a punishment for taxpayers claiming a refund for an excessive amount, and establishes a penalty of 20% of the excessive amount.

Bad Checks and Money Orders
The provision changes the penalty for bad checks and money orders and goes into effect for all checks and money orders received after May 25, 2007. The new penalty for passing bad checks or money orders less then $1,250.00 is a $25.00 fee or the amount of the check or money order whichever is less.

"Kiddie Tax" Changes
The new law expands the impact of the "kiddie tax" by raising the age for which it applies from under 18 to under 24 if a student.

Spouse Partnership May Elect Out of Partnership
The new rule allows unincorporated businesses owned jointly by a married couple to file their tax returns individually and not be treated as a partnership for tax purposes. All items in the taxpayer’s returns are divided between the spouses according to their respective interests in the venture, and each spouse’s share of income or loss from the business is taken into account in determining the spouse’s net earnings.

FICA Tip Credit
The new law modified the FICA Tip Credit so that the credit is determined based on a minimum wages of $5.15 per hour, allowing employers to receive the full tip credit despite of the Federal minimum wage increase. The provision also states that as the minimum wage increases, the amount of the credit will not be reduced.

Corporate Estimated Tax
The act increases the corporate estimated tax payment due in July, August, and September 2012 from 106.25% to 114.25% of the payment otherwise due.

Work Opportunity Credit
The passage of the new bill extends the credit by forty-four months. Now the credit is valid through August 31, 2011 for most targeted groups.

Disabled Veterans
There is an enhancement in the Work Opportunity Credit for employing certain disabled veterans who begin working for an employer after the passage of the bill.

WOTC and Tip Credit Offset by AMT
This new provision allows for use of the Work Opportunity Credit and the FICA Tip Credit to offset the Alternative Minimum Tax.

Section 179 Expensing
In addition to extending it through 2010, the provision increases the minimum amount a taxpayer can deduct annually as a Section 179 expense from $100,000.00 to $125,000.00. It also increases the $400,000.00 phase-out level to $500,000.00.

For more information on the U.S. Troop Readiness, Veterans’ Care, Katrina Recovery, and Iraq Accountability Appropriations Act, 2007 you can read the Senate Finance Committee’s summary, the House of Representatives’ technical explanation, or the Senate’s legislative text.

Letter to Congress, U.S. Treasury, and the IRS

Last week, I sent an open letter to Congress, the U.S. Treasury, and the IRS identifying a problem that can be easily fixed and beneficial to taxpayers and the IRS. Here is a press release about the letter and including an actual photocopy.

Specifically, the problem was that the IRS requires a complete financial disclosure from all taxpayers who owe in excess of $25,000.00. The complete financial disclosure includes giving the IRS extremely personal information and private financial information. The disclosure is required even if you arrange to fully pay the amount owed within five (5) years, which is agreeing to a substantial payment. The disclosure also requires substantiation of all financial information claimed. This includes providing copies of all current financial records, such as bank statements, paycheck stubs, proof of payment for monthly expenses (i.e. medical expenses, child care, etc.). As you can imagine, such a system acts as a barrier for many taxpayers to get a fair resolution. In fact, it frightens many from even attempting to address their IRS tax debt.

Congress, the U.S. Treasury, and the IRS can work together to create a more efficient and effective program. Simply raising the bar to when the IRS requires a complete financial disclosure will go a long ways towards creating that program.

IRS Kicks Home Owners While They're Down

According to the Washington Post, the IRS has bad news for homeowners who are seriously delinquent on their mortgages and hoping for debt relief. If your lender decides to modify your loan or forgive your debt, you could end up owing federal income taxes on that amount. The IRS essentially treats the amount that is forgiven as ordinary income. Lenders are even required by law to notify the IRS when they forgive the debt. This news is especially bad in the current market, where many people are finding themselves upside-down in the current market because of interest only loans or property value decreases.

Tax Evader Sentenced to 63 Months in Prison

Earlier today a federal judge sentenced convicted tax evader Elaine Brown to 63 months in prison. She and her husband Ed Brown were both convicted of tax evasion. He is expected to receive a similar sentence later this afternoon. The two were found guilty by a jury of hiding Elaine’s income from 1996 to 2003, which was $1.9 million, as well as using $215,890 in postal money orders to purchase a compound for Elaine’s dental office. The couple has defended themselves by saying that federal tax laws do not exist, but the prosecuting attorneys claim their theories are "contrary to common sense," and that Elaine "had no excuse for not paying her taxes." Source: BostonHerald.

US House Passes Minimum Wage Tax Breaks

The US House of Representatives overwhelmingly approved small business tax breaks to be attached to the new minimum wage bill in a 360-45 vote on Friday. The House tax breaks include over 1.8 billion dollars in tax cuts compared to 8.3 billion the Senate approved on a similar minimum wage bill. Although House Democrats had originally hoped to pass the minimum wage bill without any associated tax breaks, it saw problems in the Senate where it was feared the bill would not receive any necessary Republican votes without including small business tax breaks. According to Senate Finance Committee chairman Max Baucus it should take two or three weeks for House and Senate negotiators to reconcile the two variations into one bill. Source: Yahoo News.

Common Tax Questions Answered

The Plain Dealer at Cleaveland.com has compiled a list of the most common tax and IRS questions with answers from Mary Vanac. Some topics include common tax return errors, important tax deductions, help on getting a refund, amended returns, new tax laws, and more. Click here to read the full article.