Tax Policy

Taxmageddon Looms

Based on my research, it seems that on February 18, 2012 the Washington Post coined the term “Taxmageddon,” derived from “Armageddon,” the site of the battle during the “end times,” according to the Bible’s Book of Revelation.  The term is pervasive in the financial press now.  Taxmageddon is scheduled to occur on January 1, 2013. 

Federal Reserve Chairman Ben Bernanke identified the beginning of 2013 as a “massive fiscal cliff.”  Around the end of 2012, TheHill.com says the United States will face “the Unholy Trinity.”  The Bipartisan Policy Center sees a “Scheduled Policy Train Wreck” occurring.  Absent change, the Congressional Budget Office (“CBO”), the budget and economic analyst for Congress, predicts that the first six months of 2013 will see a recession and that economic growth for all of 2013 will be around an anemic 0.5 percent.

Let’s briefly unpack the underlying issues that cause these dire predictions.  First, remember that the U.S. economy is shakily wandering out of a recession.

The “Unholy Trinity” is defined by TheHill.com as being comprised of (1) the expiration of the “Bush Tax Cuts” (“Taxmageddon”), (2) debt-ceiling negotiations and (3) automatic budget cuts.

Last year, the Budget Control Act of 2011 created a “Super Committee” to devise for Congress reductions in the Federal deficit of $1.2 trillion over ten years.  If Congress failed to act before the end of the year, automatic spending cuts of about $110 billion per year would begin in 2013 and continue for a period of ten years.  The Super Committee failed to recommend deficit reductions; the automatic cuts are scheduled to begin.  One might be able to find even some economists outside of the Keynesian camp who would agree that significantly cutting government spending as the country struggles to exit a recession could pose some problems.

Basically, until last year the act of increasing the ceiling on the amount of debt that the Federal government could issue was fairly routine.   In the summer of 2011, partisan disputes rendered that process anything but routine.  The worldwide financial markets quaked as opposing Washington combatants postured.  The debt ceiling was raised just in the brink of time to avoid default on U.S. obligations.  The debt ceiling needs to be raised again around the first of 2013.  We can expect more partisan battles.

Taxmageddon is actually more than the expiration scheduled for the end of 2012 of the 2001 and 2003 Bush Tax Cuts. Among other items also contributing to Taxmageddon are the expiration of the “AMT patch” (actually expired at the end of 2011), the end of the temporary payroll tax cut, the expiration of various “tax extenders” (some actually expired at the end of 2011), and the initiation of various tax provisions under “ObamaCare.”  The cumulative result of these scheduled tax increases is predicted to raise taxes by almost one-half trillion dollars in 2013 alone!  This is the largest tax increase ever.  To put it into perspective, consider that all of the tax increases under ObamaCare – massive in their own right – for a ten year period total about the same as the pending 2013 tax increase.

So, in a nutshell, that is why everyone from the media, the CBO, and Chairman Bernanke to Senator Orrin Hatch (R-Utah) sounds like Chicken Little.  The threat is real.

Will Taxmageddon occur? Will the Unholy Trinity trigger the end of time? Not likely.  My take is as follows.  Wise long-term solutions will not be enacted anytime soon.  The general tenor of the temporary fix will depend on the November elections.  The timing of the actions will be too late in 2012 (or in early 2013) to do much tax and financial planning for 2012 based on those changes.   During late 2012, the financial markets will reflect the fear caused by the uncertainty.  Investors and businesses will be cautious as they await actions and, by being cautious, further weaken the economic recovery.

I wish I had a rosier outlook.  But, hey, I am an accountant.

Vance

Personal Taxes

Check out the new Total Tax Insights Calculator from the AICPA

Last week the American Institute of Certified Public Accountants (“AICPA”) released a free online tool, Total Tax Insights, to help U.S. taxpayers get a picture of their total tax responsibility – federal, state and local – over the course of a year.  The AICPA wants users to have a better awareness of the need for financial and tax planning and the importance of considering the impact of taxes when making important financial decisions.  You can find this tax calculator at totaltaxinsights.org.  

I recommend that you give it a try.  It is easy to use.  Completing the input form takes only a few minutes.  You may want to have your most recent federal income tax return at hand when you fill out the input page.

The results of your efforts can be eye opening.  The calculator asks for the state and locality of your residence.  It uses your adjusted gross income as your “income” number and gives you estimated tax amounts for various taxes and the various estimates of tax as percentages of your income.  I could guess pretty closely my Federal income tax burden.  I was reminded of the burden of self-employment taxes.  I knew that I didn’t pay any state income taxes in Texas.  I was certain that I paid no cigarette taxes, which the software confirmed.  However, I was surprised at the number of different federal, state and local taxes and at the amounts of those taxes that my bride and I pay – federal and state cell phone taxes, federal and state landline taxes, hotel accommodations tax, cable tax, electricity tax, gasoline tax, to name just a few.

The sheer amount of taxes and percentage of my income devoted to paying taxes depressed me.  So, I went back to the Total Tax Insights calculator and compared what I would pay if I lived in New York City.  I would pay 21% more taxes if I lived there.  I feel better now.

Vance

Tax Court

Revisiting the Hobby Loss Rules

When a case is styled Lee Storey, et vir., that is a hint that the story is about a lady.  The lady in Tax Court Memo 2012-115, issued last month, is quite interesting.

Lee Storey is a very successful attorney who has always had an interest in the arts.  (Reminds me of a lady I live with, whose biography would also be styled et. vir.)  A number of years into her marriage, she learned that her husband had been a performer with the “peppy” singing group Up With People.  (Seems like something you would know pretty early about your spouse; he must have not been too proud of his involvement with the group that has been parodied on The Simpsons and SouthPark.  I digress too much.)

When her children matured sufficiently to leave home and to allow her some free time, Mrs. Storey undertook a project of making the film “Smile ‘Til it Hurts:  The Up with People Story,” which had an initial working title of “Power and Passion: The Up With People Story” that had to be changed because internet searches for the title ended up at porn sites.  (Darn, I digress again.)   She started in earnest in 2005.  In the three years considered in the case – 2006-2008, it appears that she deducted over $750,000 in costs.  In 2010 she made her first revenue off of the project – $250.  At the time of trial, presumably in late 2011, she was still optimistic about someday making a profit.  The IRS challenged the deductions under Section 183 of Code, the hobby loss rules.

The Feds sure picked on the wrong lady.  Mrs. Storey was entirely business-like in her approach to film-making.  She took a sabbatical to attend a film school; she took an additional filmmaking course; she wrote a business plan; she hired a bookkeeper; she retained an accounting firm; she kept careful records; she bought appropriate filmmaker insurance; she hired experienced filmmakers to work on the project; she tirelessly promoted the film; she looked at different ways to create revenue.  Tax Court Judge Kroupa said that “her work product demonstrates time-consuming care and attention to detail.”  Judge Kroupa went on to analyze whether the movie-making was engaged in for profit using nine nonexclusive factors found at Regulation Section 1.183-2(b).  By my count, the IRS won one round, Mrs. Storey won five rounds, and three rounds were scored as draws.  Victory to Mrs. Storey.

The takeaway is that it is alright to do something you love and try to make a profit at it, even if you are ultimately unsuccessful (at least not yet at the time of trial).  Approach the project in a businesslike fashion and early in the endeavor document your path to profits.  Keep good records and use appropriate expertise.  Above all, don’t mess with Lee Storey.

Vance