Wednesday, February 23, 2011

Which Presidents Should We Really Celebrate?

Monday marked the official celebration of George Washington's Birthday - called Presidents' Day in some states - and a grateful nation celebrated with fireworks, parades, and half-off sales at outlet malls throughout the land. (You mat have missed the fireworks and parades, but the sales were hard to avoid!) Washington served long before the lawmakers working in the city named for him imposed an income tax. But have you ever wondered which Presidents shaped the current tax system we all know and love?

For the first fourscore and seven years of our history, we relied on tariffs to finance the government. Things started heading downhill in 1862, when President Lincoln signed the first income tax law to help pay Civil War expenses. The tax itself was 3% on incomes above $600 (roughly $10,000 in today's dollars) and 5% on incomes above $10,000 ($212,000 in today's dollars). Lincoln also appointed the first Commissioner of Internal Revenue. Clearly this is why most states celebrate Washington's birthday than Lincoln's.

Lincoln's tax was repealed in 1872, and for the next 40 years, the government raised 90% of its revenue from taxes on alcohol and tobacco. In 1909, President Taft proposed a constitutional amendment authorizing the government to impose income taxes without apportioning the burden according to state populations. Four years later, New Mexico became the crucial 36th state to ratify what became the 16th Amendment. Later that year, president Woodrow Wilson signed the Revenue Act of 1913, which imposed a progressive tax starting at 1% on incomes above $3,000 (roughly $66,000 in today's dollars) and topping out at 7% on incomes over $500,000 (a whopping $11 million in today's dollars). Wilson's administration also introduced the first Form 1040 - which explains why there's never been a national holiday for Wilson's birthday!

World War II forced Washington to raise taxes to unprecedented heights. So, naturally, President Franklin Roosevelt presided over some important changes in tax policy. He signed the Revenue Act of 1942, which imposed a 19% tax on the first dollar of taxable income (!) and raised the top rate to 90% on incomes over $200,000. (On a brighter note, it created new deductions for medical expenses and investment expenses.) In 1943, he signed the Current Tax Payment Act, which imposed withholding. And in 1944, he signed the Individual Income Tax Act, which created the first standard deduction on Form 1040.

Top marginal tax rates remained at 70% for the next 30 years, as deductions, shelters, and loopholes proliferated like bad movie sequels. In 1976, candidate Jimmy Carter declared the income tax "a disgrace to the human race." As President, he signed the Tax Reduction and Simplification Act of 1977, which replaced the old percentage standard deduction with a fixed amount ($3,200 for joint filers, or roughly $10,000 in today's dollars). A year later he signed the Revenue Act of 1978, which cut tax rates, cut the number of brackets, and established the first flexible spending accounts.

A decade later, President Reagan signed the Tax Reform Act of 1986. This once-in-a-generation law drastically cut the number of tax deductions, the number of tax brackets, and actual tax rates. At the same time, the law extended the Alternative Minimum Tax and created a new category of "passive income" that killed most old-school tax shelters. While later Presidents raised rates and expanded the number of brackets, the '86 tax act remains the foundation for today's tax system.

Are you looking for one President to blame for the monster that we know as the Tax Code? Sorry, can't help you there. But we can help protect you from the system they've all created. As for this year's tax filing deadline approaches, don't hesitate to let your friends, family, and colleagues know that we're here to protect them too!

Monday, February 14, 2011

Saint Valentine's Day Tax Massacre

Monday was Valentine's Day. Most of us celebrated the occasion with flowers or chocolate. But a small group of mob enthusiasts marked it as the 82nd anniversary of the infamous "Saint Valentine's Day Massacre." The 82nd anniversary of when Al Capone's "Outfit" gunned down seven members of rival Bugs Moran's North Side Irish gang in a garage at 2212 North Clark Street in Chicago's Lincoln Park.

Everyone knows that it took the IRS to finally put Capone behind bars. But how did it all go down? How much tax did Capone really evade? Back in 2008, the IRS released several documents relating to the case and they revealed a fascinating glimpse into the investigation that brought down Public Enemy Number One."

It all started in 1927, when the U.S. Supreme Court held that a bootlegger named Manny Sullivan owed tax on his illegal income. Two years later, President Hoover and Treasury Secretary Mellon vowed to put Capone behind bars. The Treasury Department's Special Intelligence Unit assigned IRS Special Agent Frank Wilson to the case. Wilson spent three years investigating Capone and even infiltrating "the Outfit" with federal agents in order to determine Capone's income. His break came when he found three ledgers that had been seized in a gambling raid in Cicero - then from there, traced the handwriting in the ledgers to a deposit slip from a bank in Cicero - then from there, traced the deposit slips all the way to a bookkeeper at a dog track in Miami who ultimately agreed to testify. (Wilson made further history during the Lindbergh baby kidnapping - his bright idea to record the serial numbers on the gold certificates paid as ransom helped secure kidnapper Bruno Hauptmann's arrest and become common practice in kidnapping cases.)

Wilson's investigators calculated that, from 1924-1929, Capone's share of the Outfit's earnings from "gambling, houses of prostitution, and bootlegging" totaled $1,055,375.07. (That's about $13 million in today's dollars) The IRS hit him with $219,260.12 in tax and threw in another $164,445.09 in penalties.

A federal grand jury indicted Capone on 22 counts, including "failure to file returns" (a misdemeanor) and "wilful attempt to evade and defeat an income tax" (a felony). Capone originally copped to all charges, but when he discovered the judge wouldn't be bound by the prosecution's sentencing recommendations he switched his plea to "not guilty." After a long trial that included an unsuccessful plot to bribe potential jurors, Capone was convicted, sentenced to eleven years, and fined $250,000 plus $30,000 in court costs.

Capone wasn't the only Chicago mobster who wound up answering to the IRS. The Service also won convictions against Capone associates Jake "Greasy" Guzik and Frank "The Enforcer" Nitti, among others. And the convictions inspired still more delinquent taxpayers to come forward and 'fess up, including one "big shot gambler" who showed up at the IRS's Chicago office to pay $200,000 in cash!

Capone's conviction broke his hold on the Chicago "Outfit." He spent seven years as a guest of the federal government, including four years at Alcatraz, before winning parole and returning to his home in Florida where he died in 1947. the infamous garage where the Saint Valentine's Day Massacre took place is now a parking lot. It's ironic that Capone's greatest legacy may be a Valentine to the IRS, in the form of reminding gangsters of all stripes to pay their taxes!

Saturday, February 12, 2011

The Land of Milk and Money

Tax breaks come and tax breaks go. In today's era of trillion-dollar deficits, even sacred cows like the mortgage interest deduction have come under fire. But one longtime tax break appears to remain safe, even as lawmakers gradually chip away at it. That's the deduction for medical and dental expenses. The Joint Committee on Taxation estimates that for 2011, the deduction for employer-provided health insurance and benefits will save taxpayers $115.2 billion. Deductions for medical, dental, and long-term care expenses will save $15.5 billion more.

Internal Revenue Code Section 105 (which excludes employer-paid health insurance and other benefits from your taxable income) and Section 213 (which lets you deduct your medical and dental expenses) have both been law since 1954. You would think, after all those years, the topic of "medical deductions" would be pretty settled. But you might be surprised to learn just how much taxpayers and the IRS clash over the limits of medical deductions. So with most of the country headed into the worst of flu and cold season, let's take a look at some of the more intriguing recent developments in medical deductions:

  • The IRS denied a request from the American Academy of Pediatrics to make breast-feeding costs a deductible medical expense. Although one study found that antibodies passed from mother to child could prevent the premature deaths of up to 900 babies per year, the IRS considers breast milk to be "nutrition" rather than "medicine."

  • The IRS issued an opinion stating that the cost of an "herb" may be a deductible medical expense if: (1) the taxpayer can substantiate that they have a medical condition, (2) they're purchasing the herb to treat or alleviate that condition, and (3) and they wouldn't have bought the herb "but for" that condition. However, the IRS still just says no to deductions for medical marijuana — even when prescribed by a state-licensed physician — because marijuana remains illegal under federal law.

  • Would you believe that sex change surgery is a deductible expense? The Tax Court just issued a 139-page opinion ruling that gender identity disorder is a "disease" under Code Sections 213(d)(1)(A) & (9)(B) and the taxpayer's hormone therapy and surgery were for "treatment" of that disease under those same sections. But in the same case, the Court also ruled that the taxpayer's breast augmentation was merely directed at improving her appearance and thus qualified as nondeductible "cosmetic surgery" under Code Section 213(d)(9)(a).

  • Finally, the Tax Court shot down deductions for $108,086 in visits to prostitutes and $7,373 in pornographic books, magazines, and other materials. The taxpayer, a 77-year-old tax attorney (I know, Ripley's didn't believe it either), argued they were reasonable expenses to fight depression and erectile dysfunction brought on by age. The Court noted that: (1) none of those expenses were incurred as part of any course of therapy prescribed by a doctor, (2) patronizing prostitutes is illegal in New York, and (3) really, the taxpayer should have known better!

Medical expenses in general are getting harder to deduct. Last year's health care reform raises the threshold for deducting medical and dental expenses, effective 2013, from 7.5% to 10% of adjusted gross income. (If you're self-employed or buying your own insurance, ask us if a Medical Expense Reimbursement Plan or Health Savings Account might help avoid those limits entirely!)

Now let's sew this all up. If your doctor told you you needed surgery, you'd ask for a second opinion, right? Well, the IRS performs surgery every day. They remove cash from your wallet — and they don't use anesthesia! So if you're not already doing business with us, and you'd like a second opinion on your taxes, call us! If you already are doing business with us, and you have friends, family, or colleagues who'd like that second opinion, send them our way!

Wednesday, February 9, 2011

How to Predict Super Bowl Winners?

Sunday night marked the 45th installment of America's annual salute to all things hype. Celebrities! Concerts! Commercials! If you looked hard enough, you might have even found a pretty good football game.

The day before the game, the Wall Street Journal weighed in with the kind of observation you'd expect them to make — specifically, that "the Steelers will get to keep a lot more of their season earnings, though both team's players would be a lot richer if they played all their home games in Dallas."

The difference, of course, is taxes. Super Bowl MVP Aaron Rodgers and his Packer teammates play their games in Green Bay, where they pay Wisconsin state taxes of 7.75% on income over $220,000. (Since the minimum NFL salary is $310,000, that means every Packer pays the top rate.) The AFC champion Steelers play in Pittsburgh, where they pay Pennsylvania state taxes of just 3%. That difference may not look like much, but it adds up fast. Green Bay's Rogers made $8.6 million last year, paying an estimated $3.1 million in federal income and payroll tax and $680,000 in state income tax. He would have saved $398,050 in state tax if he played in Pennsylvania. That's a lot of cheese!

Many states and municipalities have started collecting income taxes from visiting athletes and other performers. This can lead to complicated calculations to avoid double taxation. For example, if this weekend's big game had been played in Pittsburgh, Packers would have paid state tax of 3% of their game-day pay and taken a credit for that same amount against their Wisconsin tax. If the game had been played on the frozen tundra of Lambeau Field, the visiting Steelers would have paid Wisconsin tax on top of their regular Pennsylvania tax!

But Texas, site of this week's game, is one of seven states with no individual income tax whatsoever. Of course, the Super Bowl itself brought millions to the host city, even after accounting for last week's unexpected winter blast. If Texas officials had tried to tax the visiting players, on top of that economic windfall, the refs would have done well to call them for unsportsmanlike conduct!

That's probably not much comfort to the members of the 6-10 Houston Texans and 6-10 Dallas Cowboys, most of whom would probably trade state taxes for a few more W's! (In fairness, however, Saturday's Journal piece points out that Texas taxes beer at twice the rate of Wisconsin or Pennsylvania.)

Stock market forecasters swear by the so-called "Super Bowl indicator," which holds that when a team from the old National Football League (now today's NFC) wins the Super Bowl, it means a good year for stocks. But can state income tax rates help predict Super Bowl winners? This year, the high-tax Packers beat the low-tax Steelers. Last year, the higher-tax New Orleans Saints beat the lower-tax Indianapolis Colts. But in 2009, the lower-tax Steelers beat the higher-tax Arizona Cardinals. And in 2008, the high-tax New York Giants beat the lower-taxed New England Patriots. So don't bother checking tax rates before entering your Super Bowl pool!

The lesson for us is that we tend to focus on federal income tax — for most of us, it's as obvious as an opponent's defenders looming large at the line of scrimmage. But we can't forget state and local taxes, hiding in the backfield like a defensive secondary. So think of us as your financial offensive line, protecting you from all tax threats. And don't worry, football die-hards, the NFL pre-season starts in just six months, if the players don't strike!

Sunday, February 6, 2011

Tax Solutions for Groundhog Day

Punxsutawney Phil came out of his hole this week, as he does on every February 2nd, with a winter-weary nation paying extra-close attention this year. Did the fearless 15-pound forecaster see his shadow or not? Are we really stuck with six more long weeks of winter? According to stormfax.com, Phil's forecasts are right just 39% of the time, which probably puts him on par with your local TV forecasters. But that doesn't stop upwards of 35,000 people per year from gathering before dawn to see the hardy rodent appear.

Back in the 1993 film Groundhog Day, Bill Murray starred as weatherman PhilConners, sent to Punxsatawney to cover the annual festivities. That night, a blizzard hits, forcing Phil to stay overnight in town. He wakes up the next morning to find it is February 2nd again; his day unfolding exactly like the day before. Ultimately he realizes he's doomed to live the same day forever - even by killing himself he can't break the cycle.

Since then, Groundhog Day has become cultural shorthand for living the same events over and over. So, what does all this have to do with taxes? Well, last week President Obama delivered his second State of the Union address - and his comments sounded depressingly familiar to those of us who follow tax policy:
  • First, he called on Democrats and Republicans to simplify the corporate tax system. "Get rid of the loopholes. Level the playing field. And use the savings to lower the corporate tax rate for the first time in 25 years - without adding to our deficit."
  • Next, he declared that, "the best thing we could do on taxes for all Americans is to simplify the individual tax code. This will be a tough job, but members of both parties have expressed interest in doing this, and I am prepared to join them."
  • Finally, he stated that, "if we truly care about our deficit, we simply cannot afford a permanent extension of the tax cuts for the wealthiest 2% of Americans. Before we take money away from our schools, or scholarships away from our students, we should ask millionaires to give up their tax break."

Most Americans think tax simplification is a great idea. The problem, of course, is that hearing calls for tax simplification is like waking up to the same Groundhog Day over and over again. Lawmakers from both parties have sparred over corporate taxes since before former President Reagan offhandedly proposed eliminating them decades ago. They've floated endless plans to simplify personal taxes. They even have fought all year over extending the Bush tax cuts to the top 2% of earners - right up until extending them temporarily just a few short weeks ago.

Bill Murray was the perfect choice to make Groundhog Day into a hit comedy. If Hollywood made April 15th into a movie, they'd look for someone more like Stephen King to write it! But you don't have to wait for lawmakers to see their shadow before you can cut your taxes. The REAL key to minimizing that tax bill is planning. Most tax professionals do a fine job recording history. But we here at Tax Saving Solutions are here to help you write it. We'll even give you a full menu of deductions, credits, loopholes, and strategies. Punxsatawney Phil predicts you'll love the savings!