Common Sense for the Tax Code

The AICPA list of  suggestions to Congress for tax code changes caught my eye this week.  (After all, for those of us “inside baseball” tax season has already started, so it’s hard to get my brain thinking about other topics.)  For some reason known only to a secret cell at the Institute they came up with a list of 13 suggestions.  In a world full of  catchy improvement- list titles like “7 Habits”, “10 Best”,  “A-List for….” only a group of accountants would release the 2010 Compendium Of Legislative Proposals .  That said, what the authors lack in communications sizzle they make up for in common sense.  Not that we need to go through all 13, but here are my nominees for the  “Tackling the Tax Code Trifecta” (perhaps descriptive overkill in the opposite direction).

The first involves tax breaks around higher education.  The AICPA points out that there are 9 different credits or deductions related to paying or higher education.  Eligibility for each of these tax incentives varies by non-financial factors and then there are 6 different levels of phase out based on the taxpayer income.  According to the Compendium detail,  roughly 10-million families attempt to use these incentives annually.  The Treasury Department estimates 19% of eligible families skip the benefits and erroneous claims to education credits made by those the hardy souls who do apply have cost Uncle Sam $232 million. 

The AICPA recommends the creation of a single credit for all post-secondary expenses to be awarded on a per student rather than per taxpayer basis. There’s also advocacy for a uniform definition of qualified higher education expenses and consistent income phase-outs for all education incentives. 

My second winner on the list involves a similar approach for mileage deductions. What could be bad about standardizing mileage rates so there is one for business expenses and another for  personal costs related to charitable, medical and moving transit?  The authors of the Compendium want non- business deductions to be half of those for commerce related deductions.  I personally have always been puzzled by the particularly miserly charity deduction.  If you drive a meals on wheels route it’s 14-cents a mile off your AGI, and that’s only if you itemize. 

Third place on my list is probably less important than the previous two for most people.  It’s a recommendation to allow a deduction for AGI related to attorney fees and court costs connected to litigation that gives you taxable income. Again, this doesn’t apply to most people, but if you’ve gone through the courts and prevailed, that somehow feels like it’s not regular income.  My guess is most recipients would happily give back the money if they could avoid the wrong that was done to them.  What not let individuals deduct the costs the same way a business would?  Right now the law is a patchwork of eligibility based on the kind of litigation and the type of award. 

My cynical default is that these changes won’t make it into the tax code, but if you don’t ask, then you already know the answer…

Change Impact Downstream

While much has been discussed about the recent (it is actually technically over) recession in terms of long run unemployment, my work week reminded me about the impact on those still working.  Everyone is trying to do different things faster -- yet often with the same infrastructure.  While it’s tough to turn even a small business on a dime, the fact is there are plenty of people who are doing that just to keep solvent.  It’s really important though to consider the downstream impacts of these big changes on the how the company operates day-to-day.  In particular the effectiveness of internal controls can dissipate significantly when rapid change is the order of the day.

A small business facing economic duress is unlikely to think managing control risk is a top priority, but it actually is.  While the bottom line is crucial, knowing that you in fact have the correct bottom line is equally important.  Recent statistics from the Association of Certified Fraud Examiners show fraud in the workplace is uncovered by accident 25% of the time.  Compare that to the 12% of fraud discovered by external audits.  Needless to say, preventive controls are more important, as they can stop fraud before it occurs.  They also help prevent mistakes, which are also more likely to occur at a time when change is rapid and ongoing.

If it’s so important, how does one prioritize management of controls?  (It’s easier than you might think.)  Particularly in a changing environment there are a couple of items worth focusing on.  If your business doesn’t have a formal set of internal controls, make a list of the informal procedures that you believe are providing the appropriate checks and balances.  Then collect a group of folks you work with to dissect if any of those programs might be working differently (as in not working) under the new ways the business is operating.  If it involves cash, assets that can easily be transported or your regulatory responsibilities, this is a big priority.  You can make a hit list of items that are not on the short list, consider the risk to the business and then act accordingly.

How Much Tax Evasion?

So I did not give up my search for the source of the estimate that the incidence of fraudulent tax returns is up by 50%.  I will surrender on that point now.  I can’t find it.  I did find an estimate that the IRS fell short of collecting an amount of taxes equivalent to 2% of GDP in 1992.  In 2010 terms that would mean tax cheats kept $285.12 billion from the US Treasury.  The IRS reports it collected $48.9 billion in “enforcement results” in 2009.  Since GDP has grown only slightly from 2009-2010, it’s safe to assume enforcement isn’t keeping up with the estimates of evasion (even old, out-dated estimates).

To be fair, it appears the IRS is focused on materiality when it comes to looking for tax dodgers.  The recent successes in off-shore tax evasion apparently are just the tip of the iceberg.  The Wall Street Journal suggests the cost to the US Treasury from assets kept off-shore and not taxed is about $300 million a year.  That’s about 10 basis points of the estimated amount of missing taxes, but given the size of the overall numbers and the many ways to avoid paying taxes, that’s probably about as big a bite as one can get out of a focused effort. 

While I didn’t find very much in the way of hard estimates of the cost of cheating there is a ton of literature on why and when people tend to not comply with tax collection.  A study published in The National Tax Journal concludes that “tax evasion falls with higher audit rates, higher marginal tax rates, lower AGI, greater use of wage and salary withholding, reduced use of itemized deductions and exemptions, less inequality, and lower unemployment”  If these guys are right, you can bet tax collection rates aren’t getting better.  With the exception of lower AGI and perhaps higher audit rates, there’s nothing on this list that tracks to the present day situation.  An IMF study discounts the above mentioned factors and says it’s really all about being unable to calculate how likely you are to get caught cheating on your taxes and the uncertainty about the consequences of being caught. I can see the point in all of the above, but most of all I’m remembering now something an actuary friend once said to me, “Statistics are meaningless in a universe of one.”  You can’t predict what’s going to happen to you.



Avoiding New Year's Intaxication

I’m guessing it’s a select group of people who take advantage of the IRS issued 2010 Tax Statistics card.  I snagged this rare gem based on reading an article  suggesting the Treasury Inspector General for Tax Administration believes that fraudulent tax returns have increased by 50% over the past year.  My question was – up 50% from what number?  That’s a big increase, even if the base is pretty low.  Unfortunately as of yet, I do not have the answer to that question.  Still, it turns out that when it comes to statistics about taxes there’s plenty of them out there. 

Back to the big catch of the day --  the Tax Stats at a Glance card.  (Did I mention it’s in color?)  It turns out only a third of individuals filing tax returns last year had itemized deductions.  However, almost 58% of individual filers used a paid tax preparer for their return.   From where I sit, this is very good news. If economic models were correct, then it’s my belief the number of people who pay to get their taxes done would correlate highly with the complexity of their tax return.  However, the good news (if you’re an accountant) is that the belief in the inherent incomprehensibility of the US tax code apparently trumps the reality of a relatively straightforward tax year for an individual taxpayer. 



It turns out a little upwards of 300-thousand individual taxpayers have an AGI (Adjusted Gross Income) of more than $1 million.  California has the highest number of the $1-million plus returns.  Vermont has the fewest resident members of the millionaires club, only 389 residents from the Green Mountain state earned (or rather admitted earning)more than one million greenbacks.  On the other hand almost 25-million taxpayers nationwide received some earned income tax credit. 

Last, but not least – roughly 112 million people qualified for the approximately $324 billion in refunds issued last year.  Which brings me to my end of the year admonition to pay taxes responsibly and therefore avoid “intaxication”.  For those of you not familiar with this condition it is defined as  “Euphoria at getting a refund from the IRS, which lasts until you realize it was your money to start with.”

Deja vu All Over Again

So Congress did come through with tax legislation at the last minute.  Here’s my summary of highlights from the legislation.



For “wage slaves” like myself there is the reduction in payroll taxes from 6.2% to 4.2% for 2011.  According to the Tax Foundation this will result in a $1,500 reduction in taxes paid for a couple earning $75,000. The maximum savings available up to income of $106,800 is $2,316.

Many of the tax breaks due to expire, will now continue.  These include a basket of incoherent incentives to engage or abstain from certain behaviors in the marketplace.  The list includes, but is not limited to:

For individuals:

-     Extensions of the dependent-care credit and the adoption tax credit.  The adoption tax credit was made refundable through 2011 in the health care legislation.  This tax bill moves that feature into 2012 as well.

-      Teachers still get up to $250 “above-the-line” deduction for buying supplies for their classrooms.

-      Through 2012, you can still:   apply for The American Opportunity tax credit for education, use the exclusion for employer-paid education, and deduct your student loan interest.

For businesses:

-      The R& D credit is in place now through 2011.

-      The special 15-year cost recovery for certain leasehold, restaurant and retail improvements remains.

-      Expansion of bonus depreciation to 100% for new assets placed in service starting September 9, 2010 through 2011.  We’ll go back to 50% for bonus depreciation for 2012.  Then it is supposed to go away permanently. 

-   Speaking of Section 179 – earlier legislation passed this year will let you take up to $500,000 in expense for capital assets this year and next.  Unlike bonus depreciation, the Sec. 179 deduction is also available for used assets.

For everyone:

The AMT patch was passed, so the 2010 exemption will be $47,450 for individuals and $72,450 for joint filers.

The estate tax is back with a 35% rate and a $5 million lifetime exclusion.  It can be applied retroactive to January 1, 2010, or estates of 2010 decedents can elect the previous 2010 rules, with no estate tax but a limited step up in the basis of inherited assets.

For me to do next:

Now that this bill has passed I have no more excuses.  If Congress can meet an end-of-year deadline, then it’s really pathetic if I can’t do the same.  Time to get to work on the New Year’s Resolution list….