Volcker Report on Tax Reform Released

The President's Economic Recovery Advisory Board, chaired by former Federal Reserve Chairman Paul Volcker, released their report on August 27, 2010 on options for changes in the current tax system.  The Board was tasked with generating options to simplify the tax system, to improve taxpayer compliance with tax law, and to reform the corporate tax system.  The Board was created in February 2009 and consisted of 17 members drawn from industry, academia, and economics.  The Board was instructed by the president to exclude options that "would raise taxes for families with incomes less than $250,000 a year."  Furthermore, the Board did not consider major overarching tax reform, such as the introduction of a value-added tax.  The report doesn't endorse specific recommendations, but the findings could be referenced in future tax legislative proposals.  This report could also be overshadowed by the Alan Simpson and Erskine Bowles committee which will report (after the November elections) on ways to cut the federal budget deficit.

Some of the interesting options listed in the report include the following:

• Eliminating some of the penalty-free early withdrawal provisions from IRAs, such as for withdrawals for education, first-time home buyer expenses, and medical expenses.
• Eliminating minimum required distribution requirements where total retirement accounts are less than $50,000.
• Replace the numerous different long-term capital gain tax rates with a 50% exclusion.
• Limit or repeal Section 1031 like-kind exchanges.
• Have the IRS send taxpayers who don't itemize deductions a pre-filled tax return that they could simply sign or make simple updates to.
• Dedicate more resources to the IRS for enforcement actions, increase the statute of limitation period for audits, and examine multiple tax years at once.
• Increase information reporting and institute income tax withholding on "large payments" to independent contractors.
• Reduce the top C corporation tax rate from 35% (the second highest rate among developed nations) while expanding the tax base by preventing businesses possessing certain "corporate" characteristics from being classified as a pass-through entities (thereby avoiding C corporation taxes) such as a partnerships, LLCs, or S corporations.
• Reduce the amount of interest expense that can be deducted by C corporations by 10% of the amount of interest in excess of $5 million.
• Eliminate the domestic production deduction.
• Eliminate or reduce accelerated depreciation.
• Eliminate the exemption of credit unions from income tax.

New Education and Medicaid Spending Bill Enacted

On August 10, 2010, Pres. Obama signed into law $26 billion of new spending for education and Medicaid assistance to the States, H.R. 1586.  According to the New York Times, the US Senate was in such a hurry to get to their summer vacation when they passed the bill on August 5th that the Senate failed to even put a name to the bill.  The US House was already on vacation and came back for one day on August 10th to pass this nameless bill.  The cost of the bill was "paid for" by enacting $9.0 billion of tax increases "reforming" international taxation (details beyond the scope of this blog), saving $1.1 billion by ending the advance earned income credit used by low-income individuals (which appears to be a one-time accounting gimmick), by cutting food stamp money by $11.9 billion beginning on March 31,2014 (which cuts may never really happen), and by making cuts in "budgetary authority" to programs that cannot spend their allocated funds fast enough before the programs expire.

Congress has left for another day the very important work in considering the following tax matters:

• The estate tax whipsaw in 2010 and 2011,
• Extending income tax provisions that expired at the end of 2009, such as the research and experimental credit, sales tax deduction, etc.
• Dealing with the Bush-era tax cuts that expire on December 31, 2010 resulting in large income tax increases beginning January 1, 2011, and
• Patching the alternative minimum tax exemption amount for 2010 so that 22 million more middle-class taxpayers don't fall into the AMT trap.

I expect that a lot of tax law changes will occur this Fall.  But again, with this Congress, maybe not.

Financial Reform Act Signed into Law

Pres. Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law on July 21, 2010.  The Act is the most sweeping overhaul of the financial system since the Great Depression.  At over 2,300 pages, many of the provisions won't be understood for years, as various commissioned studies and regulations are completed.  We can be sure that the "law of unintended consequences" will apply to something so vast and unrefined.  For example, the limits to be imposed upon debit card swipe fees charged by banks and other fee limitations could lead to the loss to consumers of no-fee checking accounts and the reduction of benefits associated with the use of credit cards, such as cash back and travel point programs.

The Act is proclaimed to be able to prevent future financial meltdowns for which the American taxpayer will be on the hook, and to protect consumers with the creation of a Bureau of Consumer Financial Protection to be housed in the Federal Reserve.  Nevertheless, regulation of the Fannie Mae and Freddie Mac mortgage companies, which represent the largest exposure for taxpayer bailouts, was left out of this bill, as was the regulation of financing departments of auto dealers which touch the lives of most consumers.

The Act instructs the SEC to conduct a 6-month study of whether to apply a fiduciary standard of care to registered broker-dealers when providing investment advice to consumers.  Presently the fiduciary standard applies to investment advisors but not to broker-dealers.  Broker-dealers only have to recommend investments that are considered "suitable" for their customers.  If the fiduciary standard is extended to brokers, then they will be required to recommend investments that are "in the best interest" of their customers.

The Act also permanently raises the FDIC deposit insurance limit to $250,000 retroactively to January 1, 2008.  Previously the insurance limit was scheduled to drop to $100,000 after 2013.

CBO Report on Social Security

The Congressional Budget Office just released the report, "Social Security Policy Options."  Social Security outlays will exceed annual tax revenues in 2010, which is the first time since the 1983 reform.  The CBO states that if the economy recovers soon, Social Security taxes will again be sufficient to pay current expenses, but only for a few years.  By 2016, annual spending will regularly exceed tax revenues.

The CBO references the so-called Social Security "trust fund," where previous excess taxes were accumulated.  The trust fund is projected to be exhausted in 2039.  The problem, of course, is that there isn't really a trust fund.  Prior excess Social Security taxes went to pay for other government spending by purchasing U.S. Treasury debt obligations.  There is not a cash balance to draw upon as the trust fund misnomer would indicate.  To pay for program benefits in excess of Social Security taxes, the government will need to issue more debt obligations, thus increasing the national debt, or raise taxes in order to fund the redemption of Treasury securities purchased with previous Social Security surpluses.  That is one reason why this issue must be addressed now.  The other major reason is the aging of the American population who will claim benefits.  The options to address the funding shortfall can be basically categorized as lowering Social Security benefits or raising Social Security taxes, or some combination, because there isn't really 29 years worth of money on deposit in a "trust fund."

The CBO report analyzes 30 options.  The CBO proceeds under the assumption that people currently older than 55 will not be affected by any changes.  This cut-off makes it uncomfortable for people like me that are slightly younger than this age!  While the CBO did not make recommendations, options analyzed include the following:

• Increase the payroll tax rate from one to three percentage points
• Remove the upper cap on compensation subject to the payroll tax but do not increase benefits
• Lower benefits for the top 50% or 70% of earners
• Raise the full retirement age to 70
• Reduce the cost-of-living adjustments for benefits

Americans must be prepared to fund more of their retirement needs in the future.  While the Social Security program will continue to be a part of our future, the combination of benefit reductions and higher taxes will increase the need for the public to take more responsibility for their retirement income needs.  Future retirees will need to save more of their earnings for retirement during their working years while being subjected to higher taxes on those earnings.

IRS to Require Small Businesses to Pay Taxes Electronically in 2011

Prior to 2011, businesses with less than $200,000 of aggregate federal income tax, employment tax, excise tax, and etc. could pay their taxes to the government by depositing a check with a commercial bank using the Federal Tax Deposit paper coupon, Form 8109.  Beginning in 2011, all businesses (except those with less than $2,500 of quarterly tax deposits) must pay their taxes using the Electronic Federal Tax Payment System (EFTPS).  Registration with the EFTPS is required, and can take several weeks to complete.  Businesses that are currently using the paper deposit method should register at www.eftps.gov before the end of 2010 so that there is no delay in making tax deposits and incurring substantial penalties.  Failure to use EFTPS when required results in a "failure-to-deposit" penalty of up to 15% of the amount required to be electronically deposited, even if the taxes are timely paid by paper.  Payments made using the EFTPS must be scheduled by 8:00 p.m. ET at least one calendar day prior to the tax due date.  The payment is made by debiting the business' bank account registered with EFTPS.  I have found the EFTPS to be convenient and that its use helps reduce errors on the part of the government when processing tax payments.  If you are not already using EFTPS, you should consider using it for the balance of 2010.

June 30, 2010 New Home Purchase Credit Deadline Extended to September 30, 2010

Original Post
The first-time homebuyer or long-term-owner tax credits of up to $8,000 or $6,500 respectively expired generally on April 30, 2010.  The actual amount of the credit depends on several factors, including a phase-out based upon modified adjusted gross income.  However, a transition rule allows the credit to those who had a written binding contract to purchase or construct a new principal residence by April 30, 2010, and who close on the purchase or receive their certificate of occupancy by June 30, 2010.  Immediate steps should be taken to ensure that the closing or issuance of the certificate of occupancy happens on time.  The credit is claimed on Form 5405 and certain documentation such as a copy of the binding contract, the settlement statement or certificate of occupancy, and other information must be attached to the form.  The credit may be claimed on either your 2009 or 2010 tax return.  Planning may be necessary to determine the best tax year in which to claim the credit.


July 1, 2010 Update
The ending date of the transition rule has been extended from June 30, 2010 to September 30, 2010.  This will give an estimated 180,000 homebuyers who would miss the earlier date more time to complete their purchase or finish constructing their new principal residence.  Congress enacted the extension on June 30th (H.R.5623) and Pres. Obama is expected to sign the legislation shortly.

Foreign Bank Account Reports (FBAR) Due June 30th

The Treasury Department requires every U.S. citizen or resident, including all forms of organizations, having a financial interest in, or signature or other authority over a financial account in a foreign country to file a Foreign Bank Account Report (FBAR). The report is made for each calendar year using form TD F 90-22.1 and must be received by the government no later than June 30th of the next year. No extension of time to file the report is permitted. The report is a separate filing and is not included with your income tax return, although certain questions in your income tax return about foreign bank accounts must be answered. The report is required if the aggregate value of all foreign accounts exceed $10,000 at any time during the calendar year. Some foreign financial accounts may not be readily apparent.  For example, one local bank offered local companies a sweep account that paid a higher rate of interest that was actually located in the Cayman Islands!  Civil penalties for not filing on time can range from a minimum of $10,000 to the greater of $100,000 or 50% of the account value.  Criminal penalties can range from a fine of up to $500,000 plus 10 years in jail.  Clearly the US government is serious about forcing FBAR compliance.  The government assumes noncompliance is indicative of tax fraud.

The 2010 HIRE Act added new disclosure requirements for those with more than $50,000 of "specified foreign financial assets" for tax years beginning on or after March 19, 2010.  In this situation, disclosure in the income tax return is required, but this does not relieve the FBAR requirement.  The penalty for failing to disclose this information in the income tax return is $10,000 and increases $10,000 every 30 days thereafter, not to exceed $50,000.