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Call Me Paranoid, But . . .

Most of my clients are “One Percenters.”  At the risk of inciting an “Occupy Three Forest Plaza” protest, I admit that I may even qualify as a One Percenter, if you smudge the dividing line a bit.  So, I’ve got dogs in the fight about tax reform.  A recent Congressional Research Service (“CRS”) study bothers me; so does a House Ways and Means Committee hearing held last week, but not quite as much.  The United States needs to narrow significantly the gap between its expenditures and its revenues.  Sometimes, it seems that Washington and Warren Buffet want to close that divide by standing only on the shoulders of those vile One Percenters.  The first item aims squarely at One Percenters.  The second item brushes a lot more broadly.  That’s the reason I am not so concerned – a lot more voters could be affected.

The CRS report issued this month addresses the amount of tax revenue “lost” because pass-through entities – generally partnerships and Subchapter S corporations – do not pay Federal  income tax.  Thus, the income is only taxed once, as compared to two levels of tax on income of C corporations – one tax at the corporate level and another tax on the dividends received by shareholders of C corporations.  I think “lost” is dubious description of the situation.  To constitute a “loss,” one must start with the assumption that double taxation of income is an appropriate economic  phenomenon – an assumption not shared by a number of economists and some sovereign entities.  Possibly, “tax revenues extorted” is a better description.

The report concludes that over 82% of net pass-through income is “earned” by taxpayers with an adjusted gross income of over $100,000 (“rich people”).  Several lawmakers and the Obama Administration have proposed taxing large pass-throughs as corporations.  Thus, the reasoning goes that, for the most part, only rich folks are hurt by the proposal.  The tortured reasoning continues that “double-tax entities” are at a competitive disadvantage compared to “single-tax entities.”  Yes, the cost of capital may be a bit different, but I am not buying the argument that you should handicap the more efficient fiscal arrangement to give the less efficient structure a break.

On April 17, 2012, the Ways and Means Committee held hearings about retirement savings.  In preparation for that hearing, the staff of the Joint Committee on Taxation released on April 13, 2012, a document examining the present law and background relating to the tax treatment of retirement savings.  It is actually a nice explanation of the existing array of retirement savings plans, focusing mostly on defined contribution plans, such as 401(k) plans, and Individual Retirement Arrangements (“IRAs”).  After reading the JCT document before the hearings,  some Washington observers concluded that one of the things that would be under consideration at the hearings would be the repeal of the current allowance of most workers to make “pre-tax” contributions to 401(k) plans and IRAs.  These “breaks” would cost the U.S. over $460 billion in the next five years.

Witnesses at the hearing pointed out that these pre-tax earnings going into retirement savings are not exempt from taxation.  Taxes are deferred and paid when the retirement savings are withdrawn (albeit at possibly a lower tax rate).  In this election year, there was bi-partisan agreement to kick the can down the road; maybe deferrals and economic reality aren’t so bad.

I suppose that I sound a bit testy today.   I (or actually Mrs. Maultsby), too, had to write a big check to the U.S. Treasury last week; I felt the pain.

Vance

Just for Fun

Tomorrow is Tax Deadline Day – Be Careful on the Roads!

According to a study published in this month’s Journal of the American Medical Association and reported widely in the popular press, “Tax Day” – April 17 this year – is a dangerous day on the roads.   Researchers analyzed data from the National Highway Traffic Safety Administration and found that the traffic death rate on Tax Day was 6 percent higher than on other April days.

The lead author of study, Dr Donald Redelmeier, is a Canadian.  Dr. Redelmeier said he studied the United States because the U.S. tax code is so complicated and probably more stressful to taxpayers than in any other country.  Besides stress, commentators guessed that the traffic death count escalated due to taxpayers being distracted by tax filings or because people drove unfamiliar routes to the post office or to the Internal Revenue Service office to deliver tax returns. 

The study found no effect on the traffic death rate from the inception and popularization of electronic filing of tax returns.

This casual observer has one theory that the study apparently did not consider.  I wonder what is the effect on traffic deaths of tax preparers celebrating the end of tax season at the neighborhood bar after six weeks of sleep-deprivation and nail-biting?

Anyway, be careful out there!

Vance

Just for Fun

Tacky Tax Deductions

Okay, it is almost the filing due date and I am getting a little punchy.  I’ve been collecting ridiculous tax deductions lately.  I offer my special thanks to Accounting Today and the Minnesota Society of CPAs, from whom I borrowed much of my material below.  Few, if any, of these occurred in my own practice.  That’s my story and I am sticking to it.  Here are my top ten.

  • A 78-year old retired tax lawyer claimed as medical expenses about $300,000 spent on prostitutes and pornography.  He had no shame.  He took the case to the Federal Tax Court and the New York State Appeals Court.  He lost.
  • One accountant had a client who arranged a bride from Russia and wanted to write off the dowry he needed to pay to her family and the phone calls to arrange the transaction.  I’m not quite sure what kind of deduction he was trying to manufacture – maybe a casualty loss?
  • A business owner wanted to include his new speed boat as a company expense, claiming it was an employee benefit for helping the employees deal with job stress. The company was in Los Angeles. The boat was on Lake Havasu, Ariz.  Maybe the employees chilled out as they drove across Nevada.
  • A taxpayer argued that a spouse’s drug habit was a medical expense.
  • Pets are popular with taxpayers wanting to deduct everything from pet food to vet bills.
  • A client added his children’s school fees as training expenses to be absorbed by the company he runs.
  • A handyman proposed to take a $25,000 mileage deduction, even though he had only $10,000 in revenue. He justified it by saying he drove 50,000 business miles in one year.
  • An over-the-road truck driver wanted to deduct as entertainment expense the cost of female companionship while traveling.
  • A doctor wanted to deduct his hair styling costs, including hair dye, as a business expense.
  • Another taxpayer wanted to claim as a charitable contribution the market value of whole blood that the taxpayer donated.  There was actually a Tax Court case about this one.

That is about the best I can do in this sleep-deprived condition.   I’ll be more cerebral after April 17.

Vance

Tax Court

One Case – Two Enterprises – One a Business and One a Hobby

A Tax Court Summary Opinion is an opinion issued under the Tax Court’s small case procedures.  While a Summary Opinion cannot be precedential, it can be instructive.  The Tax Court addressed the issue of hobby loss disallowance under IRC Section 183 in Ryberg, T.C. Summary Opinion 2012-24 filed March 12, 2012.  One can deduct losses from a business.  One cannot deduct losses from a hobby. 

 

The case addressed the tax year 2006.  Each of the Ryberg spouses pursued an interest.  The wife (referred to herein as “Mrs. R.”) bred horses for about nine years.  The husband (referred to herein as “Bubba”) was a “professional” drag racer for about 20 years.  Both had 40-hour per week day jobs.

 

Mrs. R. was a certified horse judge.  In preparation for starting her operation, she took university courses concerning horse breeding.  She took a law school class on horse breeding contracts.   She studied the markets, attended horse auctions, and delved into the technical and business aspects of horse breeding.  Mrs. R. devised a business plan focusing on a niche market.   When she was not at her day job, Mrs. R. was working in the breeding operation and doing everything there was to do in the enterprise.  She kept a ledger and prepared monthly financial and analytical reports.  When he wasn’t drag racing, Bubba helped Mrs. R.  According to the Tax Court:  “On some occasions, [Bubba] would spend the entire weekend spreading manure for compost.”   After a series of setbacks – a bad market, West Nile virus, unusually high feed costs, her cancer and Bubba’s injuries, Mrs. R. gave up the breeding operation in 2006.

 

Bubba had a 1968 Chevrolet Rally Sport Camaro, modified it for drag racing, and started racing in 1990.  By the time the case went to trial, he had raced for 20 years and never had a money-making season.  He had a few people sponsor him; in exchange, they put their decals on his Camaro and his trailer.  He solicited drag racing tips from his buddies, but never consulted with anyone about the business aspects of racing.  The Tax Court pointed out that Bubba “allegedly tracked his expenses using a spreadsheet.”  He did not provide at trial a copy of the spreadsheet or any documents that he “allegedly” maintained.  The Tax Court seemed to conclude that his full-time job as a spray painter probably did not give him any “particular expertise in the business, financial, or economic aspects of drag racing.”

 

The Tax Court ruled that Mrs. R. had a business and that Bubba had a hobby.  Can you see the difference between a business and a hobby?

 

Vance