Tax Newsletter 1996

Clinton + Congress = Chaos

The baby boom generation is getting older, and more conservative. The 1994 elections marked a sea change in American politics. The republicans rose from underdog to leader. Congress and Clinton gridlocked and passed virtually no tax legislation in 1994. As of mid December, they appear to be gridlocked again in 1995.

There is no 1995 tax law as of January 1, 1996. I must print this Newsletter without the 1995 tax updates I like to include.

Congress and Clinton have been fighting as cats and dogs over taxes and the budget. For two years they have passed no major tax legislation, just a few badly needed technical corrections. Their current budget has scheduled the second train wreck of government shutdowns during the year end holidays.

The 1994 midterm elections marked a sea change in American politics. The republicans and democrats are fighting a war. Their prize is the political high ground for the November, 1996, elections. Their weapons are the Presidential veto and the Congressional power of the purse. Their rhetoric is shamelessly exaggerated and ruthlessly spun to hit the voters' hot buttons. The battles will continue until and beyond the 1996 elections.


Republican Contract with America

That government governs best which governs least, according to the republican Contract with America. The Contract includes specific changes which span the major issues. Change raises political fears of special interest groups, no matter the party. Whatever 1996 brings, the changes will center around the major issues, including:

Savings and investment incentives. The Contract's capital gains rate reductions raise the hackles of democrats on grounds of equity. Democrats oppose the elimination of deductions which encourage consumption over investment, such as home mortgage interest. Democrats also oppose estate tax reductions, including provisions to keep family businesses intact. Everyone has problems with social security and pension reform.

Health and welfare changes. The Contract's major tax expenditure is new tax credits for children, even at the high expense of separate tax filings. Democrats object strongly to tax reductions in the face of massive expenditure reductions to balance the budget. Social security and medicare are unsustainable with the baby boomers retiring in the next few years. Change of these high visibility programs is very sensitive. Look for pension and insurance privatization, including insurance portability from one employer to another and medical savings accounts. Reductions in the marriage penalty may also be in the offing. Welfare is expensive and hardly working. The question is how to wean recipients back to work.

Systemic income tax changes are needed to turn around the dysfunctional income tax system, which is too complex, too inequitable and too expensive. A Flat tax is a popular alternative because of its inherent simplicity. But a radical flat tax is politically unachievable. The question is how to reform the income tax without making it even more complicated, as every major change since the income tax's second coming in 1913


Tax Updates

With no major tax legislation for two years, here are some ongoing tips:

Delay taking capital gains until Congress and Clinton agree on any rate reduction.

Keep charitable receipts over $250. The charity must give you a receipt and value any substantial goods or services you get. Your cancelled check does not count, because too many people have cheated.

Consider pension plan contributions carefully, depending on your life situation. They tax capital gains at higher ordinary rates. Withdrawal may bring accounting headaches and, if you are less than 59_, penalties. When you die your estate may pay estate tax, and your heirs still pay income tax. Major pension reform is coming soon.

1.9 million missing. In 1994 the IRS put teeth into its efforts to stop tax cheats from claiming extra dependents. For four straight years taxpayers have reported more dependents. The IRS has threatened penalties and required social security numbers at younger ages (currently 2 months). In 1994 the IRS delayed refunds while it cross-checked social security numbers. There are now 1.9 million fewer dependents, who presumably never existed.

The Market Segmentation Specialization Program (MSSP) is a set of IRS training manuals which targets industries and types of deductions/credits which have shown a history of major problems, including Air Charters, Architects, Attorneys, Bed and Breakfasts, Bars and Restaurants, Entertainment, including Music, and Foreign Athletes and Entertainers, Gas Retailers, Ministers, Mobile Food Vendors, Mortuaries, Passive Activity Losses, Rehabilitation Tax Credit, Debt Cancellation by the Resolution Trust Corporation, Taxicabs, Trucking, and Wine. If you are on this list, keep excellent records, and use a professional for your business accounting and tax preparation.

The IRS will use direct deposit for your refund this year, if you do not mind losing just another bit of privacy by putting your bank account number directly into the government's computer system. They promise faster refunds. Social Security has offered the direct deposit option for years.

Privacy is going the way of the sliderule. Congress re-quires the IRS to disclose your tax information to federal and state agencies administering Federally assisted benefit programs, including Aid to Families with Dependent Children (AFDC), Food Stamps, Social Security, Unemployment Compensation, and Veterans' programs.

Telefile will now let you file your 1040EZ completely on your touchtone telephone (unless you owe money, and must also send a check). The IRS' computer calculates your tax due while you are on the phone. But the restrictions are large, this first year. You must be single and have no dependents. You must have filed a return last year from the same address, so you use the preprinted label and a special Personal Information Number the IRS sends with your tax filing booklet. The IRS expects 3 million taxpayers will use Telefile, of 23 million eligible. Many of these filers will cheat.

The IRS promotes electronic filing to automate 200 million paper tax returns. The IRS issues quicker refunds. Dishonest taxpayers have used the quick refunds to cheat the IRS of untold hundreds of millions of dollars.

The IRS should get credit for using economic reality. They are trying to learn a lesson from the CIA's recent debacle with a traitor who took large Russian bribes. Look at the lifestyle of the taxpayer under audit. Target the few people who hide large income, not the majority of honest taxpayers who fudge on their expenses, often because the recordkeeping rules are so complex.


The Wizard of OZ

The politicians are doing what we elected them to do - to distill the many diverse views in America to one set of practical and enforceable laws. If only they could do so without making us suffer the calculated crises of scheduled government shutdowns. As the saying goes, our democratic system of government is terrible. But our democracy is less terrible than any other system in the world.

The IRS is like the Wizard of Oz. The republican change of leadership in Congress has pulled back the curtain and exposed a dysfunctional IRS, running a dysfunctional income tax system. IRS' support in Congress and with the public seems at an all time low.

Senator Bob Dole, front running republican candidate for President, says I believe we must scrap the current tax code and start again from scratch.

Rep Bill Archer, House Ways & Means Chair, says The current income tax system costs, by the most conservative projections, $300 billion a year just for compliance. We have reached the point where we cannot fix it. I want to get the income tax out of our individual lives completely. I want to tear the income tax out by its roots.

Representative Dick Armey, House majority leader, says America needs nothing less than a completely new tax system.

Congress' General Accounting Office (GAO) says the IRS' efforts to modernize tax processing are at serious risk due to remaining pervasive management and technical weaknesses. The IRS has not yet fully developed and put in place the requisite management, software development and technical infrastructures necessary to successfully implement an ambitious world-class modernization effort. The IRS suffers a lack of clarity in management responsibilities.

That Congress is coming to this realization is telling. Politicians do not lead public opinion, but follow so that they can get reelected. The public has long seen the failure of the income tax system. The real and perceived inequities have decreased voluntary compliance to 83%, down from 90%+ in the 1980s. The IRS collects only 83% of the tax revenue it can count. There is no telling what revenue it cannot count.

But in the Land of Oz, nothing is as it seems. There is little chance that the income tax will change markedly. Congress cannot get there from here, because they must get reelected.

Frequent income tax legislation keeps the campaign contributions flowing. So long as politicians need to be reelected, the complex and socially driven income tax will remain alive and well. As Milton Friedman (a teacher of mine, and economic Nobel laureate) writes, only when there are new tax laws do the members of Congress have something to sell. Only then is there something that lobbyists can buy to earn their incomes.

Friedman encourages states to use Article V of the US Constitution to call a constitutional convention to 1) enact term limits, 2) repeal the income tax and the empowering 16th amendment to the Constitution, and 3) institute a flat tax.

Friedman believes, and I agree, that a flat tax ... would be both more equitable and more efficient ... than our present obscenely complex personal and corporate income taxes, while at the same time raising at least the same revenue.

Friedman believes that these reforms are not currently likely. I am sorry that I agree. We are in the Land of OZ to stay.

The income tax only raises 25% of what the federal government spends. But it enforces so many social programs that it


The Land of OZ

The IRS may be the Wizard of Oz. But we taxpayers created OZ, and left Congress to make its laws.

Congress legislated the first income tax in 1861 to finance the Civil War. After the war the income tax lay dormant for a few years, then arose as Congress searched additional sources of revenue. In 1895 the Supreme Court declared it unconstitutional. In 1913 the States considered the second and current income tax, and ratified the 16th amendment to the Constitution. 357,598 people filed their returns by March 1, and the IRS audited every one. Congress has passed major legislation every 1.3 years, and has engorged the Internal Revenue Code to 1.3 million words. The IRS has issued 5.8 million words of regulations, and has a backlog of regulations over a decade old.

The IRS and Congress argue as children in the dysfunctional land of OZ. The IRS fails effectively to advise Congress in making workable laws. When the IRS tries, Congress does not seem to listen. The IRS ends up with unenforceable laws. Voluntary compliance suffers.



Some of the burning current issues that plague Congress include:

Tax exempt groups too often abuse their tax exempt status. They lobby Congress and compete unfairly with taxpaying businesses. Congress tries to play Solomon by deciding what businesses are related closely enough to a tax exempt's purpose. I believe and suggest that equity demands we tax all income - bake sales, bingo profits, everything except pure gifts.

IRS collection efforts are a dismal failure. Even once you get in the IRS' computer system (and become part of the voluntary 83%, see above), IRS employees have a very hard time collecting overdue tax. Congress and President Clinton have directed the IRS to start a pilot program with private collection agencies and law firms to collect unpaid taxes.

It's dangerous, says Lawrence Gibbs, former IRS Com-missioner, about private collection. It's a very bad idea, says Donald Alexander, also a former IRS Commissioner. It's an awful step in the wrong direction, says Senator David Pryor. Current IRS Commissioner Margaret Milner Richardson says more circumspectfully that she is con-cerned about privacy and treating the public with respect.

Pending tax law may change this form, as you will see on in your 1995 tax booklet. The IRS prints tax forms in October and mails in late December. The IRS cannot finalize 1995 and 1996 forms until Congress and Clinton finish arguing.

Congress and President Clinton have formed a Commission to restructure the IRS. Among the commission's directions is to study making the IRS a quasi-governmental agency, like the Postal Service.


The IRS makes its own blunders, including:

Many tax experts like TCMP (Tax Compliance Measurement Program) audits because of their research value. One auditee called it an autopsy without the benefit of dying. The IRS used TCMPs so heavy handedly that Congress banned them by eliminating their budget. I have suggested for years that if Congress truly wants the IRS to do research, it should give amnesty to anyone chosen for these audits from hell.

The IRS recently threatened to tax frequent flyer mileage. It backed off right away, because it had not thought out the problems. Enforcing such a tax would be an administrative headache. In equity, there are many other fringe benefits which should be taxed, too.

Tax cheats love the Earned Income Tax Credit (EITC). Congress wants to help the working poor. The IRS manages this program very poorly. Richard M Hersch, speaking before the Senate Governmental Affairs Committee, called it Easy Income for Tax Cheats.

The US Supreme Court will decide whether the IRS may arbitrarily confiscate creditors' claims in bankruptcy. The issue is whether the IRS can take priority for its penalties over actual out-of-pocket losses suffered by other creditors. (US v Noland)

Judge Arthur N Votolato of the US Bankruptcy Court in Rhode Island imposed personal sanctions of $750 apiece on two IRS attorneys for an attitude problem - intentional, unprofessional, and unjustified conduct. It is as though the IRS never heard of response/objection deadlines, the Federal Rules of Civil Procedure, or the Rules of Bankruptcy Procedure.

IRS Historian Shelley Davis resigned in protest in December, because the IRS has no history. She says she exhausted all available internal ensure that vital documentation is not destroyed. But the IRS stonewalled her, claiming taxpayer privacy rights.

A lot of [IRS employees] were taking bribes. Davis found that the IRS destroyed all records of its Brooklyn-Manhattan Integrity Project of 1966, which investigated the massive bribery. The IRS ignores its legal obligation to turn over records of historical significance to the National Archives. The last time it did so was 1971, regarding tax assessment lists from 1909 to 1917!

The last straw for Davis was the IRS criminal investigation of her when she tried to preserve records on Nixon era IRS audits of right wing groups. We already know that Nixon ordered the IRS to investigate Nixon's enemies list, including 731 left-wing activists and organizations. The IRS set up a special Special Services Staff - the SSS, an acronym that recalls that other SS. Both used inappropriate means to reach questionable ends. History should teach the IRS that Nixon fell because of his arrogance and massive coverup.



California's Franchise Tax Board (FTB) is so efficient at collecting overdue taxes that some want it to collect all California debts. Currently the FTB collects debts for overdue child support, vehicle registrations, court ordered debt, and the Department of Industrial Relations. The IRS is much worse at collecting its debts, and will try using private collection agencies. Privacy advocates complain about potential abuse of tax records. Tax debtors complain that the private collectors will be more efficient than the IRS.

California was caught redhanded last year, as it enforces a major program to catch tax cheats. On April 28, 1995, Richard Hill was vindicated, but he has no recourse to collect damages against the State, or against the individual state officers who shut down his auto detailing business. In 1992 the Department of Industrial Relations demanded huge back taxes, interest, and penalties for workers he treated as independent contractors. He treated them correctly, as it turns out. (Appeal of Hill's Auto Detail, CT 63643 4/28/95)

This is the same California program which solicits you and me to turn in our competitors and enemies. You can call the Bureau of Automotive Repair (800-952-5210), the Contractor's State License Board (916-255-2924), or the Employment complaint line (916-464-1075 x299). These people play rough, as in the above example. Make sure you hate the person you turn in. And make sure he will not turn you in. Even if you are squeaky clean, California may shut you down.

California has not conformed generally to the Internal Revenue Code since the Tax Reform Act of 1993, the biggest change in the history of income taxes. If our legislators do not conform to the coming Contract with America changes, the Franchise Tax Board will revert to designing its own tax forms. We taxpayers will pay dearly for our politician's procrastination.

Remember California's new Limited Liability Company and Limited Liability Partnership laws. If you are starting a business with partners you get the limited liability of a corporation. Pay taxes as a partnership, which is more flexible. Transition problems make LLCs less attractive for established businesses.

December 29, 1995 © William M West This Newsletter is an overview of the year's tax news, and is not tax or legal advice. You should consult a professional to determine how these new and rapidly changing topics affect you and your 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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