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Friday
Sep082017

Do Hurricane Harvey Victims Deserve Less Federal Aid Because Texas is a Low-Tax State?

September 7, 2017

There are two kinds of thought-provoking op-eds: those that force readers to confront new ideas, and those that simply provoke the thought, “I wonder how that wound up in print?” Yesterday, tax attorneys and tax law professors Peter Barnes and H. David Rosenbloom served up the latter in a piece that is either an extremely contrarian take on disaster relief or a strained parable against means testing, welfare reform, and the “up-by-the-bootstraps” mentality.

After conceding that victims of Hurricane Harvey should receive federal aid as soon as possible, the professors contend that it should be structured primarily as federal loans, not aid – because Texas’s taxes are too low. Here’s their argument for structuring the bulk of federal aid as a loan, such as it is:

Here is why: Texas is avowedly a low-tax state. There is no personal income tax. There is no corporate income tax (although there is a surrogate tax on corporate receipts). There is no state-level tax on estates or inheritances. Texas ranks No. 46 out of the 50 states in state and local tax burden per capita, according to recent data from the Tax Foundation. It ranks 43rd in state tax revenue per capita.

Texas wants and needs federal help to rebuild from Harvey, and the federal government should provide significant financial aid. But it is grossly unfair for Texas to accept funds from all of America’s taxpayers to allow it to continue its exceptionally low-taxed ways. Unless Texas is willing to bear a reasonable share of the Harvey costs through increased state and local taxes, then the rest of the United States would just be giving Texas a handout. Better for the federal government to offer Texas a “hand-up” in the form of immediate cash support with the requirement that Texas generate tax revenue to repay that help.

Other states, like those impacted by Hurricane Sandy, are given a pass, because their residents already pay high taxes (“Compare that situation with New York and New Jersey’s in the wake of Hurricane Sandy: Those states (plus Connecticut) already pushed a significant state and local tax burden onto their residents.”). The piece then goes on to discuss how international aid is structured, referencing the debate, more commonly associated with IMF assistance, for whether a beneficiary jurisdiction should be required “to enact ‘good government’ policies, including changed tax laws” as a condition of aid.

The authors’ conclusion, buttressed by ability-to-pay arguments: “Although proud Texans often assert the state’s sovereignty, the truth is that Texas has no moral entitlement to federal aid to rebuild itself unless Texas is willing to shoulder a fair share of the cost. And that means increasing taxes on its residents to a level more commensurate with the burdens of residents in other states.”

Where to begin? A few thoughts, far from exhaustive, on this peculiar narrative:

  1. Texas is not a free rider, and Texans pay the same federal taxes as everyone else does. Even if Texans have greater fiscal capacity at the state level, they paid taxes to the entity that disburses federal disaster aid under the same rates and structures as the rest of the country.
  2. Tax rates and burdens are not an appropriate measure of disaster preparedness. One could argue—the authors hint at it—that perhaps Texas was less prepared because elected officials were unwilling to raise the revenue necessary to prepare for a storm of this magnitude. This is not, however, obviously true, and the authors don’t really make the case. Besides, high tax states are often woefully unprepared for hurricanes, too. Louisiana, which is said to be deserving of federal aid, clearly wasn’t ready for Hurricane Katrina. The states hit by Hurricane Sandy have decidedly high taxes, but didn’t allocate enough of that revenue to disaster preparedness either.
  3. Having lower state taxes isn’t an invitation to federal governmental discrimination. The crux of the authors’ argument seems to be that it’s somehow unfair that Texans pay less in state taxes than others do, and therefore if the federal government incurs an expense in Texas, it should treat it differently than it would an expense in any other state. This is not only punitive, but punitive on policy grounds utterly unrelated to the issue at hand.
  4. The federal government has no right to coerce states to have higher (or lower) tax burdens. Some people favor low-tax, low-service states; others gravitate toward high-tax, high-service states. It’s perfectly reasonable for someone to think that all states would be better off if they coalesced at a particular point on the spectrum, but it would be remarkable for the federal government to treat low-tax states as the functional equivalent of failed states at the international level, and to coerce policy changes by withholding federal aid. The federal government does have some authority under the Spending Clause to induce, but not coerce, state policy decisions that pertain to the aid in question, but the courts have never permitted such sweeping authority as recommended here.
  5. The “hand-up” vs. “handout” language of the op-ed makes little sense in this context. The argument appears designed to tweak certain views on welfare reform. Presumably, however, whether work requirements or other welfare reforms are or were a good idea, those favoring the “hand-up” approach believe that it is possible to induce lifestyle changes or facilitate opportunities that would reduce reliance on aid by enabling greater self-sufficiency. Is that the argument here? It could be, if the issue is how much states spend on disaster preparedness, but the authors only seem concerned with tax burdens, not how the revenue is spent. Even if Texas devoted a greater share of its existing budget to disaster preparedness and response, its low taxes overall would still mark it for disparate treatment under the authors’ approach.
  6. Without a clear linkage to state responsibilities on disaster preparedness and response, the federal government treating people differently based on divergent state political preferences is odious. The federal government has some authority to withhold funds from states that don’t comply with program mandates, or to incentivize behavior through certain aid programs. But conditioning hurricane relief not even on what Texas spends on disaster preparedness, but just on what its tax rates are is legally suspect, unseemly, and an unfortunate case of political point scoring in the wake of a terrible natural disaster.
Tuesday
May162017

Form 8959 Additional Medicare Tax

Several clients have asked me this year, “What is this tax from Form 8959 on my 1040.” And I spend several minutes on the phone or writing a letter to the client explaining the form, the tax, and how it is calculated. The tax is Additional Medicare Tax authorized under the American Care Act (ObamaCare) and is assessed on all income subject to Medicare tax; wages, tips, self-employment income, basically all earned income. Passive income (interest and dividends) is not subject to this tax. Non-cash wages; i.e. fringe benefits, are subject to this tax. Example, taxpayers who receive the use of a vehicle for work and are taxed on the personal use of the vehicle (reported on their W-2). The personal use is subject to this tax if total gross income exceeds the threshold.

An individual is liable for Additional Medicare Tax when the individual’s wages, compensation, or self-employment income (together with that of his or her spouse if filing a joint return) exceed the threshold amount for the individual’s filing status:

Filing Status

Threshold

Married Filing Jointly (MFJ)

$250,000

Married Filing Separately (MFS)

  125,000

Single

  200,000

Head of Household(with qualifying person)

  200,000

Qualifying Widow(er) with dependent child

  200,000

 

There are no exceptions for resident aliens or U.S. Citizens living abroad, they are subject to the tax even if over sea’s income is excluded from income tax.

Employers must withhold the tax from wages when an individual in their employ has earned income in excess of $200,000 in a calendar year without considering the individuals filing status or wages paid by another employer. And individuals who are self-employed or are employed by two or more employers and whose wages will not exceed the threshold from anyone employer but in total will exceed the threshold; should make estimated tax payments for the Additional Medicare Tax. The threshold amount for this purpose is $200,000. However the taxpayer cannot request the employer withhold additional funds specifically for this tax. But the employee may request additional withholding for income taxes which will be available on Form 1040 to apply to the tax there.

The additional tax is included in the total Medicare tax withheld from the employee’s wages for reporting purposes and is included in the Medicare number of Box 6 on the W-2.

The tax rate is 0.9% (.009) on income in excess of the threshold so for a couple filing MFJ with gross taxable income of $300,000 the tax 0.9% of $50,000 or $450.00. An individual filing single with gross income of $300,000 the tax is $900.

Calculating the tax is a three step process:

1.)    Calculate Additional Medicare Tax on any wages in excess of the applicable threshold for the filing status, without regard to whether any tax was withheld.

2.)    Reduce the applicable threshold for the filing status by the total amount of Medicare wages received, but not below zero.

3.)    Calculate Additional Medicare Tax on any self-employment income in excess of the reduced threshold.

An example is a single filer (C), has $130,000 in wages and $145,000 in self-employment income. C’s wages are not in excess of the $200,000 threshold for single filers, so C is not liable for Additional Medicare Tax on these wages. Before calculating the Additional Medicare Tax on self-employment income, the $200,000 threshold for single filers is reduced by C’s $130,000 in wages, resulting in a reduced self-employment income threshold of $70,000. C is liable to pay Additional Medicare Tax on $75,000 of self-employment income ($145,000 in self-employment income minus the reduced threshold of $70,000).

The method is the same for other filing statuses with the threshold increasing or decreasing depending on the filing status as shown in the above table.

The additional tax withheld is included in box 6 of the W-2; Medicare tax withheld and is added to the income tax withholding amount from box 2 of the W-2 when reported on Form 1040. The tax is calculated again using total income on Form 8959. The tax amount is shown on Form 1040 under the Taxes section increasing the filer’s tax liability and the tax paid through withholding paying the tax.

I end with this is a tax intended to fund Medicare services and ObamaCare with a tax on high income filers and is a separate tax on previously taxed income; essentially double taxation of income. A rare occurrence in American taxation as it has been policy to avoid double taxation. Will this tax be rescinded under the changes proposed by the Trump administration has yet to be seen? Typically taxes once enacted stay even when the purpose they were enacted for have long since past.

Monday
Apr242017

§1231 Loss and Basis



 

Types of Tax Property

This tax year I encountered a different treatment of property under the IRC. A partnership a client was invested in chose to cease operations and dissolve to stop the losses. Receiving the K-1 his share of the loss was under IRC §1231. Under the IRC property is defined and named by code sections addressing the tax treatment of property; §1245, 1250, and 1231 to name a few of the code sections. The code section dealing with business property is §1231 and it has a few quirks when capital gains and losses come into play.

Identifying §1231 Property

Normally depreciable property and real estate are not capital assets. But depreciable personal property and real property used in a trade or business and held for more than one year which is not inventory or held for sale to customers or intangible property is capital property under §1231 and includes:

  • ·         Trade or business property held for more than one year and  compulsorily or involuntarily converted;
  • ·         Capital assets held for longer than one year in connection with a trade or business or a transaction entered into for profit and compulsorily or involuntarily converted;
  • ·         An unharvested crop on land used in a trade or business and held for more than one year, if the crop and land are sold, exchanged, or involuntarily converted at the same time to the same person;
  • ·         Certain livestock but not poultry; and
  • ·        

Gain Loss Treatment

Generally when §1231 gains exceed §1231 losses for a taxable year, all of the §1231 gains and losses are treated as long-term capital gains and losses. When §1231 gains do not exceed §1231 losses for a taxable year the gains and losses are not treated as gains and losses from sales and exchanges of capital assets. Or, §1231 losses exceed §1231 gains all of the §1231 losses and gains are treated as ordinary income and losses. Transactions where §1231 property is sold, exchanged, or involuntarily exchanged are reported on Form 4797. Unlike capital asset exchanges are not netted against each other but are reported as individual transactions.

Recapture

When §1231 property is subject to depreciation recapture, only the §1231 gain that exceeds the amounts recaptured and taxed at ordinary income tax rates. Gains or losses disallowed by other rules is not taken into account in determining §1231 gains and losses.

Recapture of Net §1231 Losses

A taxpayer with net §1231 gains that exceed losses for the year must recapture past net §1231 losses by treating the current year’s net §1231 gain as ordinary income to the extent of unrecaptured net §1231 losses for the five previous tax years on a first in, first out basis; i.e. starting with the oldest §1231 loss, the next oldest until the current year gain or prior year losses are used up.

Compulsory or Involuntary Conversion

The capital gain and ordinary loss rules of §1231 apply to gains and losses from the compulsory or involuntary conversion of §1231 property unless the non-recognition rules for involuntary conversions apply.

Summary

When dealing with business property or non-equity (stocks, bonds) be aware of the nature of the property and keep track of your prior losses and depreciation.  These can influence or eliminate a capital gain or at least reduce it. 

Thursday
Feb162017

Missing Contractor SS#

A client called recently with the dilemma of a contractor who did excellent work refusing to provide a social security number. The contractor had just finished dealing with the after effects of identity theft and did not want to risk it again.

It was understandable someone who has dealt with identity theft did not want to risk suffering through the fear, expense, and inconvenience again. However; the Internal Revenue Code requires the contractor provide his or her Tax Identification Number (TIN) to those who have paid for his services..

The client did not want to stop using the contractor, many business owners do not want to end business relationships because of the contractor has refused to provide a TIN. Yet she as the employer of the contractor is responsible for reporting payments made to him.

The solution provided by the IRS when the contractor refuses to provide a social security or taxpayer identification number (TIN) is for the payer to immediately start backup withholding at 28%. This makes it imperative to request the TIN when the relationship starts and to start the withholding when the contractor fails to provide it.

It is best to give the contractor the W-9 before employing the contractor making employment conditional on its return. If it is returned incomplete or is missing the identifying number (social security/TIN) keep that copy for your records. Before December 31st send a second Form W-9 by registered mail requiring a return receipt.  And most importantly begin backup withholding and continue backup withholding until you receive the TIN.

If the registered letter is returned with an incomplete W-9 file or unopened file with the contractor’s records that you do have and the green postal receipt as proof you requested the information and did not intentionally ignore the requirement to file complete reports.

For each year the person works for you make a request for the information using Form W-9 and keep track of the responses. For those that do not provide a TIN withhold 28% of the payment and submit the payment to the IRS by the end of the quarter by check or EFTPS. Next time I will cover how to report this to the IRS.

Thursday
Aug062015

What are Statutes of Limitations?

Statutes of Limitations are deadlines established by Congress in the Internal Revenue Code for the assessment of taxes and the making of credits or refunds to taxpayers to ensure timely tax examinations. Statutes of Limitations (SOL) are intended to prevent the examination of a return many years after a return is filed. Possibly long after documentation and responsible parties for the filed return are no longer available. Or, long after the demise of a troubled business. Generally the SOL limit the time a tax assessment can be made to within three (3) years of a return’s due date or filing date, whichever is later. The day the return is filed the SOL begins to run counting down the days the Service has left to examine a return and make a determination if additional taxes or a refund are due.

The SOL for a return timely filed on April 15th will end on April 15th three years following. Example: The SOL for a return filed April 15, 2014 will end April 15, 2017. If the return is filed late the filing date still is the start date of the SOL. Example: A return due October 15, 2012 is filed December 12, 2014. The SOL starts on December 12, 2014 and ends December 12, 2017. If the IRS files a substitute return the SOL starts on that date and the SOL clock is reset when the taxpayer files a return for that year replacing the substitute return with theirs. Example: The Service files the substitute return Feb 3, 2015 for the 2012 tax year. The taxpayer motivated by a notice of deficiency prepares and files a 2012 tax return May 14, 2017. The SOL for the Substitute return is Feb 3, 2018 and for the taxpayer’s filing is May 14, 2020.

The SOL applies to the taxpayer too limiting the time for filing amended returns, applications for refunds, or requests for credit to the SOL period. The Service is legally prohibited from making a refund or credit if the request is filed after the SOL ends. If the taxpayer disagrees with the findings of a return examination the Service will provide an administrative appeal only if sufficient time remains on the SOL. Otherwise the taxpayer must take it to court or seek an SOL extension.

Agreements between the Service and taxpayer to extent the SOL are termed “consents” and are made using various forms dependent on the return filed and type of extension sought. The extension allows the taxpayer to present additional evidence and the IRS time to complete an examination. Consents are one of two types; a) Fixed Date terminates on a specified date, b) Open-ended exist for an indefinite length of time, usually 90 days after either the taxpayer or Service sends the prescribed notice ending the agreement. The extension can be extended by agreement between the IRS and taxpayer. Some consent agreements may be restricted to specific tax issues and can be either fixed date or open-ended.  Restricted agreements are only made if certain conditions exist.

A taxpayer refusing to sign an extension leads may lead to assessments of taxes the Service determines to be due. Usually the taxpayer receives a Notice of Deficiency and administrative options are generally closed to the taxpayer in resolving the tax issue.

Bankruptcy proceedings suspend the SOL until the bankruptcy proceedings end at which time the SOL starts counting down the remaining time.

There is a special case where the SOL is extended to six (6) years when gross income reported on the return is understated by 25% or more.