Tax Newsletter 2003


The Internal Revenue Code is an abomination. The thing is a colossal mess, 9,500 pages of gibberish. You canít find many people who say...give me some of my money back. There are alot of people who resent the fact that they canít figure out the Internal Revenue Code. Next year, I think we need to put a major reform proposal on the table.Ex Treasury Secretary Paul OíNeill


Complexity imposes a dead weight on the economy. We are going to focus next year, to a large degree, on working with Congress to pursue meaningful simplification. Mark Weinberger Treasury Dept Assistant Secretary for Tax Policy


The IRS is simply outnumbered. The tax system continues to grow in complexity, while the resource base of the IRS is not growing and in real terms is shrinking. Basically, demands and resources are going in the opposite direction. ex IRS Commissioner Charles O Rossotti


Most informed observers are justifiably horrified at the complexity of the IRC. The cost of taxpayer compliance with this code is over $80Billion per year, more than 8 times the cost of the IRS budget. The sheer size and complexity in itself can be a source of disrespect for the law. Therefore, it is a worthy, though difficult and uncertain, challenge to pursue simplification to the maximum extent possible. Ex IRS Commissioner Charles O Rossotti


The Republicans will probably control the Presidency and both houses of Congress for the full two year term of the 108th Congress, for the first time in 50 years. They barely took control of the Senate in the 2002 elections, with 51 out of 100 seats. They passed the biggest tax law in decades, the Economic Growth and Tax Relief Reconciliation Act (EGTRRA), when they controlled the 107th Congress for a few weeks in early 2001. This year they will try to make EGTRRA permanent. (see Tax Tips, right column)

Tax Cuts are the Republicansí mantra. Washington will conduct its usual political infighting and lobbying, before deciding next yearís pork barrel tax laws. Bush and the republicans want many types of tax relief, for example, general tax rates, capital gains rates, marriage penalty, double taxation of corporate dividends, and doubling of child tax credits. They have put price tags on a few specific tax initiatives, including:

         Refundable tax credits to buy health insurance for workers whose employers do not offer it. ($92Billion over ten years)

         Permanent extension of research and development credits, which currently expire in 2004, to encourage business to develop new technologies. ($54Billion over ten years)

         Charitable contribution deductions for taxpayers who have insufficient Schedule A deductions to itemize. ($30Billion over ten years)

Simplification is the politiciansí mantra. The Bush will use the Reagan model, which produced the milestone Tax Reform Act of 1986. Reagan made tax reform a 1984 campaign promise, then a focus of the first half of his second term of office. The 1986 act was a substantial reform, what they did was really quite good. It has eroded alot since then. The 1986 act eliminated many targeted breaks cluttering up the tax code, but Congress has spent the past 16 years adding new complexities. Ex Treasury Secretary Paul OíNeill


Tax Tips

Annual tax planning is not hard, you just have to do it. Defer income and accelerate deductions. Sell losing stocks to offset gains, then to deduct a maximum capital loss of $3,000. Donate appreciated stocks to charity, instead of cash. Watch Alternative Minimum Tax (AMT), which grows like topsy.

EGTRRA phases in many tax cuts in 2002 and 2003. The 10% tax bracket will benefit many low income taxpayers. Most of the other tax rates go down Ĺ% again this year. But beware, that EGTRRA disappears, as Cinderellaís pumpkin, on December 31, 2010. The Republicans did not have enough Senate votes, under the Byrd rule, to make EGTRRA permanent. They will try again in 2003, and estimate the ten year cost of making EGTRRA permanent to be $373Billion.

Education earnings are tax free, so long as someone in your family uses the distributions for education. The republicans have made these plans look a lot like school vouchers. Contribute over $100,000 to Section 529 Tuition Trusts, depending on the plan you choose. Private schools can now compete with state governments to offer Tuition Trusts. Coverdale Education Savings Accounts replace Education IRAs and increase the contribution to $2,000. You can direct your own investments, and spend the funds on K-12 and vocational schools. Other EGTRRA education deductions include $3,000 for college tuition, unlimited student interest (which used to be limited to 60 months), and permanent employee benefit plans, up to $5,250.

Retirement plans are bigger and better, even a little simpler. IRA contributions increase to $3,000. Business pension plan contributions increase in many ways, for example 401Ks to $12,000 (in 2003), and profit sharing plans to 25% or $40,000. Taxpayers over 50 years of age can make additional catch up contributions in some of the plans. Required Minimum Distributions are much simpler. Phase outs limit many of the increased retirement benefits to lower income taxpayers.

The Estate (or death) tax exclusion is currently $1Million, and increases by 2009 to $3.5Million. In 2011, EGTRRA sunsets. Instead of death tax repeal, the exclusionreverts to $1Million.

Review your estate plan. The Republicans wish dearly to make EGTRRA permanent, and they may have the votes. Even so, the last time Washington killed the death tax, about 20 years ago, they reversed themselves in a few years. There are two presidential elections and four Congressional elections before 2011.

The death tax in 2010 will affect only .3% of all estates. Many, like the organization of the affluent, Responsible Wealth, and members such as George Soros and Paul Newman, like the death tax because it promotes economic equality. Two members, William H Gates Sr and Chuck Collins, co-founder, just wrote Wealth and our Commonwealth: Why America Should Tax Accumulated Fortunes.

Eliminating the estate tax is wrong. It doesnít affect that many people. The very, very rich can afford to pay taxes. says Edgar M Bronfman, President World Jewish Congress and former head of Seagram.

Other tax changes in 2002 and 2003 include:

         Congress promoted business investment with unlimited special first year depreciation under new section 168K until Sep 10, 2004. The old section 179 first year depreciation continues, too.

         Business employee fringe benefits now include retirement planning services, health reimbursement arrangements, adoption, child care, and a permanent general education deduction up to $5,250.

         Attorney fees for investment and wage recovery suits are miscellaneous deductions, according to most courts.You might pay extra tax, because the 2% miscellaneous deduction is not deductible for AMT.

         Interest on payment of individual overdue taxes is not deductible at all, according to most courts. This is another reason to incorporate your business.

         Workers displaced by trade actions of other countries get health insurance credits.

         IRS will not tax frequent flyer miles, unless you sell them.


Death Spiral

Voluntary compliance is slowly declining in a death spiral. The internal revenue code grows too big and too complex. Over 50% of all taxpayers, and virtually all Congressmen, pay preparers. IRS does not have the resources to enforce the complex rules, as voluntary compliance wanes. One day Washington will have to reform taxes.

Not just simplification. The politicians seem always to find other priorities to avoid simplification. Bush says he wants to simplify the Income tax, but he has not announced specific plans. Perhaps he hopes to avoid the shameless feeding frenzy by lobbyists and special interests, once they learn of specific plans.

Consumption tax is the best replacement for the Income tax. It favors investment, and is easy to collect. The Europeans call it their value added tax. It would subsidize the poor, just as the current Income tax. When voluntary compliance with the Income tax falls too far, Washington will find it easy to make the hard transition to a consumption tax.


High Income Scams

Itís fraud, if the high income scams depend on keeping [IRS] several steps away from the individualís tax return so they arenít discovered in an audit. says ex IRS Commissioner Sidney Cohen. IRS could send people to jail; instead it offers amnesty. In May, IRS announced that a few taxpayers disclosed under amnesty $16Billion in improper or dubious tax deductions. This exceeded our expectations and I frankly had the highest expectations for the program, said Larry Langdon, head of IRSí Large and Midsize Business Division. IRS does not give amnesty to most of the rest of us.

William E Simon Jr, Californiaís Republican gubernatorial candidate, may have been one scammer, according to an IRS suit. Another scammer broke the code of silence, sued a promoter, and tipped off IRS. The promoters had tried to hide their scams by prohibiting disclosure. IRS has changed its rules to require disclosure by investors and promoters. Simon may have done nothing wrong, but he did lose the election.

As in the Enron frauds, tax shelter promoters used fancy names like FLIP, Tract, Campus, and Blips. High income scam techniques include corporate owned life insurance, offshore trusts and credit cards, basis shifting, contingent liabilities, foreign currency, and zero coupon municipal bonds. All segments of the tax community are aghast.

         The IRS is creating incentives for the wrong behavior. Rep Lloyd Doggett (D-Texas)

         People donít realize how phony these transactions are. IRS sends an enormous message to the business community, saying tax shelters are a no-lose proposition. For alot of us, this is really about respect for the law. Stanford law professor Joseph Bankman

         We want everyone to know we are committed to ensuring everyone pays a fair share, including those who have the resources to move money offshore or engage in abusive schemes or shelters. Noone should get a free ride at the expense of the honest taxpayer. ex IRS Commissioner Charles O Rossotti


IRS Problems

IRSí everyday problems affect all of us, most seriously the low income. The Taxpayer Advocate released its first major report ranking well known IRS problems:

         Do not depend on IRS for telephone support. Callers are often unable to speak with a Customer Service Representative, says the Advocate. The telephone queues are so long that IRS disconnects many callers, sometimes saying to call back later. When you do connect, an IRS employee gives you an incorrect answer more than one time in four.

         Multiple definitions of a qualifying child lead to confusion and errors, for the dependency exemption, earned income credit, child credit, dependent care credit, and head of household status.

         The refundable earned income credit is too complex for the low income taxpayers it benefits. Many do not claim it when they actually qualify. Many claim it when they do not qualify. IRS has lost $Billions to fraud. Taxpayers whom IRS has disqualified for wrongfully claiming it have problems qualifying again. IRS delays many refunds to try to ensure they are correct. IRS examinations to ensure compliance are lengthy, and too often wrongfully intimidate taxpayers to give up. When IRS refunds in error, it rarely can get its money back.

         IRS misapplies tax estimates and deposits too often. Requirements for tax estimates (and business deposits) are difficult to understand.

         IRS notices are not clear. IRS sends notices to 25% of all return filers, for over 225 different types of errors. These notices often concern math errors, refunds, and estimated tax payments. Too many taxpayers have to call or send written requests, says the Advocate. This problem, as many others, is especially acute for low income and poorly educated taxpayers.

         Refunds can take much too long.

         Reporting capital gains and losses on Schedule D is much too complex.

         Obtaining employer identification numbers is difficult and time consuming. Taxpayers cannot file tax returns and open bank accounts.

         Low income taxpayers often pay preparers to file, and to get refund anticipation loans at allegedly usurious fees. Most only file to get refunds of overwithholding and earned income tax credits. Congress wants IRS to help for free.

         IRS handles offers in compromise arbitrarily and too slowly. Different IRS offices interpret rules differently. IRS has not defined very well the types of offers it will accept. IRS can barely retrain its collection officers from collecting taxes to forgiving taxes.

         Alternative Minimum Tax (AMT) is too difficult to compute, and is growing too rapidly.

         IRS examinations take too long. IRS must finish within 3 years, for most returns. It cannot charge interest after 18 months (12 months after 2003).

         Nonfilers and underreporters are the tip if the iceberg of voluntary noncompliance. IRS cannot easily find these people. IRS does not take the time to understand their situations, and assesses grossly incorrect tax most of the time.

         IRS takes far too long to process innocent spouse claims. Congressí rules are complex and tedious. The courts have forced IRS to consider the other spouseís arguments in an adversarial process. IRS must exercise the wisdom of Solomon in determining which spouse is truly innocent.

         IRS takes too long to provide copies of tax returns and other documents.


Inside the IRS

The IRS is simply outnumbered, says ex IRS Commissioner Charles O Rossotti. He wants IRS to even the numbers with a 51% budget increase, to $1.9Billion.

Bush doesnít think IRS can handle such a large budget increase, and silenced Rossotti. Rossotti himself concluded as much before he took the job Ė ie, that the IRS management structure is even more troubled than its antiquated technology. Rossotti was IRSí first highly experienced, high tech, manager, not a tax lawyer. His five year term ended on November 6, 2002, and everyone liked his performance. Bush has yet to name a replacement. Donald Alexander, ex IRS Commissioner, quipped that the hours are impossible, the pay mediocre, but you get lots of abuse.

Telephone and email scammers pose as bank employees or IRS agents to get confidential information, like your social security number, bank account number, and password. US Mail scams sometimes forge US Government forms, such as form W9 that confirms your social security number. Report US mail scams to the Postal Inspector. Report tax scams to IRS at 800-829-0433. Find IRS Tax Fraud Alerts at


Investment Basis

What did you pay for that stock you sold? You may have been scared in this down market and sold stock you held for many years. You must have good records to prove your cost (basis) of any asset, not just stocks. If you cannot document your estimate, IRS says your basis is zero. Pay tax on the entire gain.

One solution is to give the stock to charity. You get a full deduction for the fair market value of publicly traded stocks. Another solution is to hold until you die, and get a write up in basis. At least until 2010, when EGTRRA eliminates the death tax.



Many IRAs have losses in this down stock market. It may be a good time to convert your IRA to a Roth IRA, especially if your other income is also down. If you already converted this year, you might recharacterize a Roth IRA conversion back to a traditional IRS, by December 31.

Distribute and deduct Roth IRA, losses as a miscellaneous deduction, subject to 2% of AGI. But you might pay AMT, since 2% miscellaneous deductions are not deductible for AMT. You may also pay 10% penalty on the distribution, if you are under 59Ĺ.

Beware that you may pay more tax with traditional IRAs and qualified pension plans. One major assumption that most people make, and that makes these plans so attractive, is that they will pay tax on distributions at a lower tax rate. When you retire, what will be your tax rate?



California conformed to the Internal Revenue Code, but only as of January 1, 2001, not for all the new tax laws since. I continue to appeal to my readers to complain vociferously to their legislators. California needlessly complicates your taxes and costs you money by constantly being in a state of nonconformity.

California did conform to Federal tax laws relating to:

         Pension and education provisions of EGTRRA. Sacramento had to fix California law, which would have invalidated entire plans, for excess contributions allowed by IRS but not by California.

         Relief for victims of terrorism.

         Child and dependent care credits.

California, but not IRS, recognizes registered domestic partners, such as gays and older heterosexuals, whose joint social security would be less if they married. Tax benefits include head of household status, dependency exemptions, and deductions for dependentsí medical expenses.

3.3% withholding on real estate sales will speed collection of California tax, and create problems. You pay on the gross sale price if you have just $1 of gain, whether you owe the tax or not. Many will merely give California an interest free loan until they file their returns and get their refunds. A few will have to contribute cash to the escrow, just to close the sale. A few will have to pay Federal Alternative Minimum Tax, because California tax is not deductible for AMT. If you might be one of these unfortunates, make sure to call me well before your escrow closes.

Sacramento has raised taxes to fund a $21Billion deficit (as of this writing), despite politiciansí protests that they would not raise taxes. The bigger tax increases, ranked by the budget impact over two years, are:

         Net Operating Loss suspension for two years. ($2Billion)

         Stock option withholding on exercise of nonqualified options, to 9.3% from 6%. ($400Million)

         Forgiveness and recapture of bank debt reserves. ($300Million)

         3.3% Real Estate withholding. ($225Million)

         Enhanced collection and settlement activities. ($212Million)

         Teacher tax credit suspension. ($170Million)

         Forgiveness of interest & penalties to encourage settlement of high risk and delinquent individual taxes where collection is in doubt. ($145Million)

         Interest increase on underpayment of estimated tax and corporate tax. ($48Million)

         Energy surcharge increased maximum. ($30Million)

         National Heritage Preservation credit two year suspension ($3Million)

Nonresidents and part year residents now pay tax a little differently for their out of state activities. California law was silent on some issues, and possibly unconstitutional on others. The new law is supposed to be revenue neutral. Still a few individuals will pay a lot more, a few a lot less.


William M West prepares tax returns and plans to save tax for business, investors, and individuals.

© William M WestThis Newsletter is an overview of the yearís tax news, and is not tax or leogal advice. You should consult me or another tax professional regarding your tax situation. You may use any material herein if you credit me by name, telephone, address, and issue date;and send me a full copy of your publication.

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Last Updated 1-23-03
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