Tuesday, August 31, 2010

Tax Reform Report A Letdown For Actual Reform

Tax Reform Report A Letdown For Actual Reform


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Q: What do former Federal Reserve Chairman Paul Volcker, AFL-CIO boss Richard Trumka, General Electric CEO Jeffrey Immelt and billionaire Penny Pritzker have in common?

A: They’re all part of an exhaustive effort to examine the problems with the U.S. tax code–an effort that is likely to be ignored by Congress, at least in the near term.

These folks and other notables (including Harvard economist Martin Feldstein, venture capitalist John Doerr, TIAA-CREF chief executive Roger Ferguson and UBS Americas Group CEO Robert Wolf) are members of the President’s Economic Recovery Advisory Board, a panel that that President Obama set up in the earliest days of his administration. On Friday, the group released its long-awaited report on tax reform options.

Now we know why there was little fanfare surrounding the release, which occurred on a sleepy August afternoon while Congress is in recess and Obama was away on vacation. The problem with the 130-page report, as Tax Policy Center research associate Howard Gleckman points out, is that it includes no recommendations about how to reform America’s increasingly Byzantine tax code. “[T]his report is a huge missed opportunity,” writes Gleckman. “Obama might have used this exercise to jump-start a debate over fundamental tax reform. Instead, the report does nothing to fill the policy vacuum that is being filled by an argument over what to do about the decade-old Bush tax cuts.”

So what does the report actually say? It discusses the advantages and disadvantages of an array of policy options, like eliminating the alternative minimum tax, lowering the corporate tax rate, modifying capital gains taxation and eliminating tax expenditures. It’s useful as a primer for anyone wanting to know more about the complexities of the U.S. tax code and probably should be required reading for anyone with a hand in creating legislation to overhaul the tax system, whenever that may be.

But it’s not likely to be anytime soon. With the economy still slumping and elections looming, look for lawmakers to take a pass on making tough tax decisions, such as whether to let the Bush-era tax cuts expire as scheduled at the end of the year.

“We think that an extension of the Bush tax cuts for all income levels is growing more likely by the day,” says Brian Gardner, a financial analyst with Keefe, Bruyette & Woods, in a research note out Monday. “The biggest remaining question in our mind is whether the extension of the tax cuts is two years or one year (more likely).”

Friday, August 27, 2010

Consider State And Local Taxes Before You Take Capital Gains

Consider State And Local Taxes Before You Take Capital Gains

Thinking of selling before rates rise? First consider the state and local tax bite.

Should you rush to take long-term capital gains before Jan. 1, when the top federal gains rate is set to rise from 15% to 20%? That depends, of course, on many factors, including whether you'll be needing cash or otherwise wanting to liquidate a holding in the next few years anyway.

But investors often overlook another key variable: the state and local tax bite. "It's kind of a forgotten-about tax," reports Carl DiNicola, an Ernst & Young partner in Irvine, Calif. It shouldn't be; 42 states tax gains and only a few of them have lower rates for long-term gains, making state tax a big deal when you take profits.


At the federal level, ordinary income such as salary is taxed this year at a top 35% rate, more than twice the gains rate. But New York City residents pay the same top 12.9% state/local rate on salary and gains. Oregonians pay a top 11% rate and Californians a top 10.6% rate on both. In fact, among the highest tax states, only Hawaii, with a top 11% rate on ordinary income, cuts long-term gains a break; they're taxed at a top 7.25% rate.

In reality, then, you may not be deciding whether to pay a 15% tax now or 20% later but whether to pay, say, a 25% tax now or 30% later. "It may in many cases be unwise to sell something this year just to get the lower [federal] tax rate," say Kaye Thomas, a tax lawyer and author of Capital Gains, Minimal Taxes. Here are additional pointers:

Investigate the quirks.

Each state has little crazy rules," says Barry Horowitz, director of state and local tax for Eisner & Lubin in New York City. New Jersey, for example, doesn't allow taxpayers to carry forward capital losses, as is allowed for federal tax purposes. Tennessee taxes capital gains from the sale of mutual funds but not individual stocks. New Jersey, Connecticut, Kentucky and Ohio exempt gains on their own state's bonds from tax.

Sunday, August 22, 2010

Auto expense allowance vs. expense reimbursements

Auto expense allowance vs. expense reimbursements

Many employers provide certain employees with an auto expense allowance via a fixed monthly or periodic payment. Unless the arrangement meets the “accountable plan” business connection, substantiation, refund of excess payments and reasonable period rules under Treasury Regulation 1.62-2, the allowance must be treated as taxable wages to the employee, subject to withholding and payroll taxes. It also most likely is treated as compensation under the company’s 401(k) plan and is subject to the appropriate withholding election and employer matching contributions.

The employee is able to deduct the appropriate auto expenses incurred on his or her individual return per Internal Revenue Code (IRC) section 162, subject to IRC section 274 substantiation rules. The deductions are treated as miscellaneous itemized deductions under IRC section 67, which limits the deduction to the extent all such deductions exceed 2% of a taxpayer’s adjusted gross income. Also, the amount is not deductible for Alternative Minimum Tax purposes. These rules severely limit the benefit of the deduction to the employee.

Generally it’s better for the employee if the employer adopts a plan that meets the requirements of Treasury Regulation 1.62-2. If so, the allowance is not taxable to the employee. The employee must forgo claiming deductions for the expenses incurred; however, that’s not a big deal as noted above. Complying with such rules is burdensome for both the employer and employee and may result in the employee paying some of the allowance back to the employer.

I have a simpler solution. Provide the employee an expense reimbursement in lieu of the allowance. The reimbursement can be capped at the amount of allowance. The employer will reimburse the applicable employee using the IRS mileage rate times the number of substantiated business miles up to a maximum desired amount.

For example, an employer was providing an employee a $300 monthly auto allowance and treating it as W-2 wages because it did not have an “accountable plan” that complied with Treasury Regulation 1.62-2. The employer changed the arrangement to provide the employee a monthly mileage reimbursement using the IRS mileage rate up to $300 per month. This reimbursement is not treated as W-2 wages. However, the employee cannot deduct the expenses relating to the business miles being reimbursed. Again, not a big deal.

The savings comes from excluding the $300 from wages for the employee and avoiding payroll taxes on the payment for the employer. It also may reduce certain compensation based insurance premiums and other retirement plan contributions.

The mileage substantiation can include calendars, dictation transcripts, or daily mileage logs. I use a daily log. It’s easy. I have not heard that any of my clients who use the reimbursement system have employees who don’t turn in records substantiating the miles needed to obtain the employer’s maximum reimbursement.


I spent it here in the office learning how to blog.