Tax Newsletter 1997

New Laws

Congress makes the tax laws (and makes them obscenely complex. It scattered many small tax revisions this year amongst numerous non-tax laws, including health, pension, jobs, and welfare:

  • Luxury auto excise tax (9% in 1996) phases out through 2003. The luxury base ($34,000 in 1996) increases to $36,000 in 1997, then by inflation. All other luxury taxes (eg, boats, airplanes) are eliminated.
  • Airfare excise taxes expire December 31, 1996. Congress will probably reinstate them in 1997.
  • Safe harbor for independent contractors prevents IRS from reclassifying employees. Both IRS and California try at every opportunity to reclassify independent contractors as employees, in order to collect more payroll tax. To qualify for the safe harbor, you must obey the rules to the letter.
  • Home office deductions are now available for storage of business inventory.
  • State tuition savings plans get favorable tax breaks, except for high income phase outs. California does not have such a plan, yet
  • S corporation reforms allow up to 75 shareholders, which can be trusts and nonprofits; and increased operational flexibility. California does not conform to these Federal regulations.
  • Foreign transactions are more reportable, and more taxable. Unreported gifts carry 35% penalty. US taxpayers who expatriate must report, or pay penalties.
  • Leasehold improvements are deductible when you destroy them, such as when you remove them to make room for a new tenant.


New Pension Laws

  • Nonworking spouses can make $2,000 IRA contributions.
  • Delay your IRA and other retirement distributions without penalty beyond age 70 1/2. as long as you keep working.
  • Life insurance payments for the terminally and chronically ill, while they are still alive, are more likely to be tax free.
  • Pensions are taxable only in the state in which you currently reside. California was in the forefront of states that tried to track and tax retirees after they had moved out of state.
  • IRA distributions used for medical expenses and insurance are now exempt from early withdrawal (before 59_ years of age) penalty.
  • 15% excise tax on retirement distributions over $155,000 is suspended until 1999.
  • Highly compensated employees can make greater contributions.
  • SIMPLE (Savings Incentive Match Plan for Employees) plans for small employers are exempt from nondiscrimination tests, but the maximum contribution is lower. SIMPLE plans work well for employers who are not highly compensated, and have few employees.

Bill of Rights

The Taxpayer Bill of Rights 2 may be the most important tax legislation of the year. It is outrageous that Congress and the President had to make a law to force IRS to treat people fairly. Congress had to change the law in some of these circumstances. But IRS did not push hard for these changes, as it should have done. IRS must now:

  • Vest a Taxpayer Advocate with independent powers to resolve taxpayer problems; and to report directly to Congress.
  • Reward anyone who provides information leading to the collection of tax, in civil as well as criminal matters.
  • Award reasonable attorney's fees if you beat IRS in court. Unless IRS can prove it was substantially justified. Even if you do not agree to extend the statute of limitations for the IRS to take more time.
  • Pay penalties to taxpayers whom it damages recklessly, or, in some cases, intentionally, up to $1 million.
  • Track and notify Congress of IRS employee misconduct, such as taking bribes, paying informers (see page 3), and invading taxpayer confidentiality. For example, Geoffry P Coughlin, who worked for IRS in Massachusetts plead guilty last year to reading tax records of friends and of famous people he did not even know. These criminal offenses carry punishment of 5 years in prison and $250,000 fine.
  • Make regulations prospectively, not retroactively. But Congress can and still does make prospective laws.
  • Notify taxpayers in many more circumstances, such as when IRS must guess how to apply a payment, terminates an installment agreement, or tries to collect tax from a jointly liable person (as in a divorce or business dispute). IRS must also notify people annually of unpaid tax due.
  • Hold harmless from tax liability volunteer board members who are not involved in a nonprofit's tax problems.
  • Match interest owed to IRS with interest owed by IRS. IRS too often thinks heads I win, tails you lose.
  • Abate interest, as well as penalty, where IRS has procrastinated or erred.
  • Accept tax return filings through private delivery services (such as Federal Express) in addition to the US Postal Service.
  • Send organ and tissue donation cards with all refunds this coming tax season.

 

Term Limits

Tax simplification is essential.

Congress makes the tax laws, and makes them obscenely complex. Normal people cannot understand the rules, and increasingly fear that the laws are not fair. Voluntary compliance with the income tax is declining.

Congress must get reelected, so they will not simplify taxes. Constant change in the law keeps political contributions flowing. A simple, stable, law would no longer entice big money contributions to Congressmen who couldn't deliver.

Congressional term limits would simplify the tax laws. Congress would not have to raise money for reelection. Without term limits, Congress will continue to fiddle while Rome burns.

As Congress fiddles, the income tax is slowly dying. Voluntary compliance is declining, according to the IRS, to about 80% of the tax people owe, down from 90+% in the 1980s. The income tax raises only about 25% of what Congress spends. The future is toward easier taxes to collect, such as payroll and excise taxes, and user fees.

 

Restructure the IRS

I'm an optimist. I believe the IRS can be trained to do something useful, said presidential candidate Bob Dole. The last election season was not good for the IRS.

I want to tear the income tax out by its roots, said Bill Archer (R-Texas), Chair of the House Ways & Means Committee. IRS complains that such talk hurts employee moral.

Congress is fed up with IRS. But Congress hampers IRS, too. As with sausage, one should not look too closely at the making of laws. Congress and the President make all sorts of unseemly deals to reach compromise. Politics is and always will be muddled.

Congress has established a special Commission to Restructure IRS, headed by Bob Kerry (D-Nebraska) and Rob Portman (R-Ohio). We will see what they do about the gang that can't shoot straight.

 

Can't Shoot Straight

Congress' Government Accounting Office (GAO) has found that IRS lacks sufficient accounting systems even to produce an auditable financial report. IRS cannot reconcile its receipts, or its expenses.

Congress cut IRS' budget to contain its $4 billion fiasco. Jim Lightfoot (R-Iowa), Chairman of the House Appropriations Subcommittee says IRS has wasted this much and more trying to upgrade its 1960s vintage computer systems. $4 billion wasted, and IRS will try again.

Congress threatened to cut 5,000 unneeded IRS employees. IRS wasted two years for 4,000 employees to catch nonfilers. But the GAO could not find any indication that IRS turned nonfilers into voluntary taxpayers. IRS complained, and Congress restored this part of its budget at the last minute.

Congress forced IRS to take common sense steps to treat taxpayers fairly in Taxpayer Bill of Rights 2.

A lot of [IRS employees] were taking bribes, discovered IRS Historian Shelley Davis. IRS forced her out when she went public over its destruction of records, and misleading (or lying to) Congress. Now she is writing a book and encouraging the Congressional Commission to Restructure IRS to look into these problems.

IRS answers only 1 in 5 telephone calls for help. As with private industry, IRS is emphasizing automated help. Get recorded tax topics and the status of your refund: Federal 800-829-4477 and California 800-338-0505. Internet tax help and forms are available: Federal www.irs.ustreas.gov and California www.ftb.ca.gov.

Congress has told IRS to try using private collection agents. The GAO finds IRS collection processes to be rigid, costly, and inefficient. Congress hopes that private firms will do better. IRS and many tax preparers have objected on privacy grounds to disclosing taxpayer information to private industry. The trial program includes California.

Tax fraud referrals by IRS are 57 times more likely in Virginia, than in New Mexico. IRS' bureaucratic management systems can do little to detect nor to correct such large differences. Such uneven enforcement feeds popular fear that IRS is unfair.

 

Audits

IRS lender audits compare the income and expenses on your tax return with loan application(s). IRS begins the audit as a civil investigation. It can prosecute you as a criminal, depending on the discrepancies it finds.

IRS financial status (AKA economic reality) audits regularly invade our privacy. These audits compare a taxpayer's income with his lifestyle. This is a commendable audit technique, when used judiciously. But many IRS auditors improperly use for everyone these questionnaires and other invasive audit techniques. IRS should 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. Thomas W Wilson, Jr, Acting IRS Assistant Commissioner (Examination) has warned: Examiners must evaluate the facts and circumstances of each case and apply judgment.

IRS can and should do much better to collect taxes fairly, and to advise Congress in making fair laws. IRS does neither so well as it should. It is the gang that can't shoot straight.

 

Courts

The Courts are overwhelmed trying to interpret the obscenely complex laws. Sometimes the decisions are for the taxpayer, sometimes against.

Punitive damages related to personal injury are fully taxable, says the Supreme Court. Court judgments are seldom tax free, anymore.

Interest on unpaid taxes may be deductible, or it may not. The courts are slowly wrestling with the 1986 law, now ten years old. Different courts are reaching very different decisions, some very favorable to taxpayers. The Supreme Court will probably have to decide this issue.

The District Court dealt IRS a major defeat in its attempt to collect payroll taxes from an employer on tip income without auditing each employee. (Morrison Restaurants v US) IRS is upset, because restaurant employees do not report tips, and it is easier to pursue one big employer.

IRS blackmailed Jack Checksfield, a tax preparer who owed back taxes, to inform on Noles, one of his clients. The court recently chastised IRS and threw out the tainted evidence from this informer.

 

Quick Tax Topics

IRS requires identification numbers to combat rampant fraud. Social Security Account Numbers (SSANs) are for US citizens and residents. Individual tax identification numbers (ITINs) are for foreign dependents and nonresidents to file US returns. US embassies and consulates will help nonresidents to get ITINs. IRS' computers are programmed to reject any exemption or other benefit if you do not have a number. The only exception is children less than one month old.

Employees should lease their business autos. If they buy, they cannot deduct the interest, which IRS calls personal.

Luxury auto depreciation limitations do not apply to vehicles over 6,000 pounds, including Chevy Suburban and Tahoe, Toyota Land Cruiser, Lexus LX450, GMC Yukon, and AM General Hummer.

Debt forgiveness income is taxable. IRS has tightened its rules, including required 1099s. For example, a real estate deal goes sour, and the lender cannot collect from you. The lender sends you a 1099 showing that you owe tax on the debt forgiveness. You may fit one of the exceptions, such as being bankrupt or insolvent. You may have heard the Boston Harbor advertisement, which promised to help you to evade the tax by intercepting the 1099. The California Attorney General stopped that scam.

Depreciation is complex and errors are common. IRS has finally announced a procedure to correct past errors. California has rejected these same simple rules. (Rev Proc 96-31)

IRS will allow check the box election for an unincorporated business to file and to pay tax as either a partnership or a corporation. Congress will likely confirm in 1997 this IRS administrative action.

California

California taxes are much more complex, too. California has its own set of bureaucrats to enforce slightly different rules. Our legislators conformed only piecemeal to Federal rules, imposing a very high cost on all of us to comply.

  • The crazy quiltwork of credits grows this year to include rice straw, transport of donated food products, farm workers' housing, and enhanced oil recovery. Why these? Lobbyists for these industries (who get preferential tax deductions in California) seem to have done a good job.
  • The Franchise Tax Board (FTB), Board of Equalization (BoE), and Employment Development Department (EDD) are implementing an Integrated Master Plan. They will exchange information and work together to collect taxes more efficiently. They are just getting around to doing what the Legislature told them to do on July 8, 1994.
  • (888) 334-3300 is the BoE's toll-free number to report tax evasion on the BoE's sales and fuel taxes.
  • The FTB is very efficient at collecting overdue taxes. So efficient that I usually advise people to make sure to pay California, even if they do not have the money to pay IRS. The FTB is now, or will be soon, collecting other California taxes and fees for the Department of Motor Vehicles, County District Attorneys for child support, Court judgments in criminal cases, Department of Consumer Affairs, Department of Real Estate, Department of Insurance, Secretary of State, Department of Social Services, and all other departments which cannot justify not doing so.
  • California has finally conformed to rules that Congress made in the last few years on moving expenses, bonus and other depreciation, and estimated tax calculations.
  • California has not conformed yet to rules that Congress made in the last few years on club dues, lobbying, real estate professionals, and S Corporations.

 

New Health Laws

  • Self employed health deductions increase to 80% over nine years (from 30% in 1996).
  • Medical Savings Accounts (MSAs) are health plans for small businesses. Contributions are not taxable, and medical benefits are exempt from tax. High deductibles make MSAs less expensive than regular health plans, and more attractive if you don't already have one.
  • Long term health care rules define which insurance and medical expenses are deductible, and which insurance income is exempt from tax. The rules confirm what tax preparers have been doing for years, but now the tests are more rigorous.
  • Medicaid motivated asset transfers are felonies. It is a criminal offense to dispose of assets for the purpose of obtaining Medicaid eligibility. For example, a severely ill grandmother might give away her home and savings to her family. The government wants grandma's assets to pay for her care.

December 19, 1996 © 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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William M West Certified Public Accountant
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