Income Tax Planning For Large Estates

If field goals were suddenly worth four points and touchdowns were worth five, football coaches would change their strategies. This type of scoring change has occurred in the estate planning field, but many people keep using their old playbooks.

Recent income and estate tax updates have adjusted how the planning game should be played. If your estate plan was drafted before they came into effect, reconsidering how you structure your estate could save you tens of thousands, or even millions, of dollars.

The Changing Rules

To understand these rule changes, we should rewind to the year 2000. The federal estate tax only applied to estates exceeding $675,000 and was charged at rates up to 55 percent. Long-term capital gains were taxed at 20 percent. Since then, the amount that can pass free of estate tax has drifted higher, to $5.43 million in 2015, and the top estate tax rate has dropped to 40 percent. On the other hand, the top ordinary income tax rate of 39.6 percent when coupled with the 3.8 percent Net Investment Income tax is now higher than the federal estate tax rate.

Although the top capital gains tax rate of 23.8 percent (when including the 3.8 percent Net Investment Income tax), remains less than the estate tax rate, these changes in tax rate differentials can significantly modify the best financial moves in planning an estate. While estate tax used to be the dangerous player to guard, now income taxes can be an equal or greater opponent.

Besides the tax rate changes, the biggest development that most people’s estate plans don’t address is a relatively new rule known as the portability election. Before the rule was enacted in 2011, if a spouse died without using his or her full exemption, the unused exemption was lost. This was a primary reason so many estate plans created a trust upon the first spouse’s death. Portability allows the unused portion of one spouse’s $5.43 million personal exemption to carry over to the survivor. A married couple now effectively has a joint exemption worth twice the individual exemption, which they can use in whatever way provides the best tax benefit. Portability is only available if an estate tax return is filed timely for the first spouse who dies.

From a federal tax standpoint, if a married couple expects the first spouse to die with less than $5.43 million of assets, relying on portability is a viable strategy for minimizing taxes and maximizing wealth going to the couple’s heirs. Estate planning for families with less than $10.86 million in assets is now much more about ensuring that property is distributed in accordance with the couple’s wishes and with the degree of control that they wish to maintain than it is about saving taxes. However, state estate taxes can complicate the picture because they may apply to smaller estates.

Below are a number of plays that families who will be subject to the estate tax should consider to optimize their taxes in today’s environment. Although many of the techniques are familiar, the way they are being used has changed.

The New Estate Planning Plays

Empowering Your Plan’s “Quarterback”

A successful quarterback has a solid group of coaches providing him with guidance, but is also allowed to think on his feet. Similarly, the quarterback of an estate, the executor or a trustee, needs to be given a framework in which to make his or her decisions but also flexibility regarding which play to run. Today’s estate planning documents should acknowledge that the rules or the individual’s situation may change between the time documents are signed and the death or other event that brings them into effect. Flexibility can be accomplished by expressly providing executors and trustees with the authority to make certain tax elections and the right to disclaim assets, which may allow the fiduciaries to settle the estate in a more tax-efficient manner. Empowering an executor has its risks, but building a solid support team of advisers will help ensure he or she takes the necessary steps to properly administer the estate.

Maximize the Value of Your Basis Adjustment

It’s a common misconception that lifetime gifts automatically reduce your estate tax liability. Since the two transfer tax systems are unified, lifetime gifts actually just reduce the amount that can pass tax-free at death. Lifetime gifts accomplish marginal wealth transfer only when a taxpayer makes a gift and that gift appreciates outside of the donor’s estate. In the past, people generally wanted to make gifts as early as possible, but that is no longer always the most effective strategy due to income tax benefits of bequeathing assets.

One big difference between lifetime giving and transfers upon death is the way in which capital gains are calculated when the recipient sells the assets. With gifts of appreciated assets, recipients are taxed on the difference between the transferor’s cost basis, typically the amount the donor paid for the asset, and the sales price. The cost basis of inherited assets is adjusted to the fair market value of the assets on the date of the owner’s death (or, in a few cases, six months later).

When choosing which assets to give to heirs, it is especially important to make lifetime gifts of assets with very low appreciation and to hold onto highly appreciated assets until death. If a beneficiary inherits an asset that had $100,000 of appreciation at the donor’s death, the basis adjustment can save $23,800 in federal income taxes compared to if the beneficiary had received the same property as a lifetime gift. Unfortunately, the basis adjustment upon death works both ways. If the bequeathed asset had lost $100,000 between the time it was purchased and the owner’s death, the recipient’s cost basis would be reduced to the current fair market value of the property. Therefore, it is advantageous to realize any capital losses before death if possible.

Holding onto appreciated assets until death is appealing for income tax purposes, but might not be advisable if the asset is a concentrated position or no longer fits with your overall portfolio objectives. For these types of assets, it’s worth analyzing whether the capital gains tax cost is worth incurring right away or if you should pursue another strategy, such as hedging, donating the asset to charity or contributing the property to an exchange fund.

Choosing not to fund a credit shelter trust upon the first spouse’s death is a perfect example of maximizing the value of the basis adjustment. These trusts were typically funded upon the first spouse’s death to ensure that none of the first spouse’s exemption went to waste. Since the portability rules allow the surviving spouse to use the deceased spouse’s unused exemption amount, it is no longer essential to fund a credit shelter trust. Instead, allowing all of the assets to pass to the surviving spouse directly allows you to capture a step-up in basis for assets upon the first spouse’s death, and then another after that of the second spouse. Depending on the amount of appreciation and the time between the two spouses’ deaths, the savings can be substantial.

Annual Gifting

Making annual gifts is a traditional strategy that remains attractive today. In addition to the $10.86 million that a couple can give away during their lifetime or at death, there are also some “freebie” situations where gifts don’t count towards this total. You can make gifts up to the annual exclusion amount, currently $14,000, to an unlimited number of individuals, and you can double this amount by electing to gift split on a gift tax return or by having your spouse make separate gifts to the same recipients.

Transferring $14,000 may not seem like a meaningful estate tax planning strategy for someone with more than $11 million, but the numbers can add up quickly. For example, if a married couple has three married adult children, each of whom has two children of their own, the couple could transfer $336,000 to these relatives each year using just their annual exemptions. If the recipients invest these funds, the future appreciation also accrues outside of the donors’ estates, and the income may be taxed at lower rates.

Contributing the annual exclusion gifts to 529 Plan education savings accounts for the six grandchildren can accelerate the gifting process and increase the income tax benefits. A special election allows you to front-load five years’ worth of annual exclusion gifts into a 529 Plan, which would currently allow $840,000 in total gifts to the six grandchildren. In this scenario, the grandparents would not be allowed to make any tax-free gifts to the grandchildren during the following four tax years. Since assets in a 529 Plan grow tax-deferred and withdrawals for qualified educational expenses are tax-free, you can realize substantial income tax savings here. If you assume the only growth in the accounts is 4 percent capital gains, which are realized each year, that results in about $8,000 in annual income federal tax savings per year, assuming the donor is in the top tax bracket.

You can also pay a student’s tuition directly to the college or university, since these payments are exempt from gift tax. This exception applies to medical expenses and health insurance premiums as well, as long as payments are made directly to the provider.

Given that annual exclusion gifts don’t impact the $5.43 million lifetime exemption, I recommend making these gifts early and often, but remember to give away cash or assets that have very little realized appreciation. The earlier you make a gift, the more time the assets have to appreciate and pay income to the recipient.

Lifetime Charitable Giving

Earlier I mentioned that you want to avoid giving away appreciated securities during your lifetime. The exception to that rule is a gift to charity. By donating appreciated securities that you have held for more than one year, you can get a charitable deduction for the market value of the security and also avoid paying the capital gains tax you would incur if you were to sell the asset.

If you know you have charitable intentions, it is more effective to donate appreciated securities earlier in life, rather than at death, since doing so removes future appreciation of the assets from your estate.

Using Trusts to Increase the Effectiveness of Transfers

Lifetime transfers to standard irrevocable trusts are no longer as appealing as they used to be, now that the estate tax rate is closer to the capital gains rate. Assets transferred to irrevocable trusts during the grantor’s lifetime typically do not receive a basis step-up upon the grantor’s death. Therefore, determining whether it is more appealing to make lifetime transfers or bequests in a specific circumstance requires making assumptions and analyzing probable outcomes.

Nonetheless, funding certain trusts in conjunction with other planning techniques can increase the planning’s effectiveness. An intentionally defective grantor trust (IDGT) is one of the most appealing types of trusts for wealth transfer purposes, because the donor is treated as owner of the trust assets for income tax purposes but not for estate and gift tax purposes. A defective grantor trust is a disregarded entity for tax purposes, so any income that the trust earns is taxable to the grantor. By paying the tax on trust income, the grantor effectively transfers additional wealth to the beneficiary.

Another popular strategy is for a grantor to make a low interest rate loan to a defective grantor trust. The trust then invests the funds. So long as the trust’s portfolio outperforms the interest rate charged on the loan, the excess growth is shifted to the trust with no transfer tax consequence.

One of the common ways to cause a trust to be intentionally defective is for the trust document to allow the grantor to retain the power to substitute assets held by the trust for other assets. Assuming a trust has this provision, it is very powerful to routinely swap highly appreciated assets held by the trust that would not be eligible for a basis step-up with assets of equal value held by the grantor that have little to no appreciation, such as cash.

Rather than funding a credit shelter trust upon the first spouse’s death, a surviving spouse might choose to receive all of the assets outright and then immediately fund an IDGT that includes the power to substitute assets. The trust’s income would be taxed to the surviving spouse, allowing for additional wealth transfer, and the grantor could use the swapping power to minimize the income tax cost of the lost basis adjustment.

Any transfer technique, such as a grantor retained annuity trust (GRAT), that allows a donor to transfer assets without generating a gift is also valuable, since it helps preserve the lifetime exemption amount as long as possible, thus maximizing the assets that can benefit from adjusted basis.

Finally, trusts can be useful for keeping assets out of your estate that never should have been included in it. For example, wealthy individuals should generally purchase life insurance through an irrevocable trust, rather than directly in the insured individual’s name. Life insurance owned by decedents is includible in their taxable estates. By creating a trust funded through annual exclusion gifts and having the trust purchase the policy, you can ensure that the estate tax does not take 40 percent of the policy’s proceeds.

Avoid Paying Estate Tax on Income Tax

While the term “income in respect of a decedent” (IRD) might be obscure, it’s important to understand it, since it’s one of the worst deals in town. IRD is income that a decedent was entitled to but did not receive prior to death. While unpaid salary and accrued interest are common examples, the biggest risks lie with retirement accounts and annuities.

Retirement accounts, such as 401(k)s and traditional IRAs, are typically funded with pretax money and taxed on the decedent’s estate tax return at their market value on the decedent’s date of death. However, because these are pretax assets, the beneficiary ultimately has to pay tax on the income before receiving it. In a simple example, if a decedent has a $1 million IRA that is being taxed on the estate tax return at 40 percent in 2014, the recipient would also need to pay additional tax on withdrawals from the IRA when he receives it. Assuming no growth in the assets and that the beneficiary is in the top income tax bracket, taxed at a rate of 39.6 percent, the recipient would need to pay $396,000 income tax as a result of the bequest and the estate would pay $400,000 of estate tax. This results in a total tax of $796,000 from the $1 million of assets. Compare this with a taxable account, in which assets would have their cost basis adjusted to the fair market value on the date of death, so the recipient typically needn’t pay much, if any, income tax to access the assets. Therefore, the tax would only be $400,000 – about half of the amount applied to the IRA.

The additional tax is a bit overstated in the example above, because the estate tax paid on the IRD can be an itemized deduction that is not subject to the 2 percent floor. Nonetheless, it illustrates the point that it is better to minimize IRD and the resulting double taxation if possible.

It may make sense to take distributions from your own pretax accounts in certain situations, because paying the income tax during your life allows you to reduce your ultimate estate tax exposure. Converting traditional retirement accounts to Roth accounts can also help maximize the value of your estate. Most people will want to avoid annuities too, not only because of their typically high fees, but because they are treated as IRD and do not receive a basis adjustment upon the owner’s death.

The right play for your estate plan has become even more specific to your situation: where you live, how you invest, your life expectancy, your goals and priorities, and your future life plans. With no one-size-fits-all answer, it’s important to run financial projections to understand both the income and transfer tax consequences of your choices, so you can determine the best moves for your situation. Make sure you have someone on your team that can accurately analyze what’s best for your situation and, above all, keep your game plan flexible.

How To Benefit From Tax Diversification

Tax diversification is integral to a well-structured retirement plan. By holding assets in accounts with different tax treatments, such as traditional IRAs, Roth accounts and taxable investments, you can balance current and future tax benefits and gain flexibility to deal with unexpected circumstances.

The Three Types Of Investment Accounts

Many investors look down on taxable investment accounts because of the taxes they must pay each year on interest and dividends, as well as any gains resulting from sales. However, such accounts do offer several benefits. First, they are incredibly flexible. There is no restriction on the types of investments you can make on a taxable basis. And while both traditional and Roth-type retirement accounts are subject to annual contribution limits and to penalties for early withdrawal, there is no limit on contributions to a taxable account, and there are no penalties when you need access to the funds before your retirement.

Qualified dividends and capital gains are taxed at favorable rates in taxable accounts (zero for lower-income taxpayers, 15 percent for most taxpayers and 23.8 percent for high-income taxpayers). Also, investments sold at a loss can be used to reduce one’s tax liability. Since you can generally control when you sell an investment, you can control when you pay much of the tax liability that such accounts generate. The government again favors taxable investments upon the owner’s death. At that time, the cost basis is adjusted to the fair market value, and no capital gains tax is due if the estate immediately sells the holdings.

At first glance, tax-deferred retirement accounts, such as traditional 401(k)s, traditional IRAs and similar plans, may seem to be the most appealing savings options because, by reducing your current tax bills, they give you the biggest upfront benefit. Since none of the income is taxable until withdrawals are made, you may be able to save more overall as the benefits continue to compound.

Regrettably, savers can wind up paying for this upfront tax benefit later in life. Distributions from tax-deferred accounts are treated as ordinary income, even if the growth in the account was generated from investments that would have been taxed at lower capital gains rates in a taxable account. So you would effectively split any profits in tax deferred accounts with the government. If an account grows by 10 percent per year and your tax rate stays the same, the eventual tax liability grows by that same 10 percent. In addition, the Internal Revenue Service generally requires retirees to begin taking certain minimum distributions from tax-deferred accounts at age 70 1/2, which can force you to generate taxable income at inopportune times. Furthermore, investments in a tax-deferred account do not receive a basis adjustment when the account holder dies. Beneficiaries will need to pay income tax when they withdraw assets from these accounts.

Tax-free or Roth accounts can be hard to beat. Although there is no immediate tax deduction for contributions to these accounts, all of the profits go to the investor. The government receives its share at the outset, then current account income and qualified distributions are never taxable. As a result, $1 million in a Roth account is worth significantly more than $1 million in a tax-deferred account, because the balance in a Roth account can be spent during retirement without having to pay any taxes. Another benefit of Roth IRAs in particular is that the IRS does not require distributions from them the way it does from traditional retirement accounts (though such distributions are required from Roth 401(k)s).

Of course, there are drawbacks to tax-free accounts, too. For one, funding a Roth account is more difficult. It takes $15,385 of pre-tax earnings to contribute $10,000 to a Roth account, assuming a 35 percent tax rate. In addition, there’s always the possibility that future legislation could decrease or eliminate the benefits of Roth accounts. If, for example, the federal government or individual states lowered tax rates or shifted to a consumption-based tax system, a Roth IRA would have been a poor choice compared with a traditional IRA, since there is no upfront tax benefit.

Choosing Which Account To Fund

Some rules of thumb can help you determine which types of retirement accounts to use. First, you should have sufficient safe, easily accessible assets in a taxable account as an emergency fund. Six months of living expenses is a good starting point, but the actual amount varies based on your expenses, the security of your current job and how quickly you could get a new job. Funds that you will need access to before retirement should also be kept in a taxable account.

If an employer matches contributions to a retirement plan, you should, when possible, contribute enough to get the full match. Any employer match will automatically be allocated to a tax-deferred account, but you should determine whether the plan will provide a match even if you contribute to a Roth account.

The common wisdom says that you should contribute to a traditional IRA or 401(k), rather than a Roth IRA or 401(k), if your current tax bracket is higher than the tax bracket you expect to occupy in retirement. If the reverse is true, a Roth IRA is the default choice. Although these guidelines are good starting points, savers are generally best served by keeping some assets in each type of account – which is the idea of tax diversification.

People’s lives and future tax legislation are inherently uncertain. Even if you expect your federal tax bracket to remain the same in retirement, it might go up if tax rates go up overall or if you move to a higher-tax state. There is no way to know exactly what your situation will look like in any given year of your retirement. You should have some assets in each type of account, but the particulars of your circumstances will dictate their relative size. As with other sorts of diversification, there is not a one-size-fits-all plan.

Going Above And Beyond Retirement Savings Limits

Selecting the best retirement plans for your situation is beyond the scope of this article, but some planning can allow you to funnel much more money into tax-advantaged accounts than you might have otherwise expected.

Some employers offer defined contribution plans with higher limits than a 401(k), and it is very easy for self-employed individuals to set up SEP IRAs. For high-earning small-business owners, it may be worthwhile to set up a defined benefit (pension) plan, which can allow for much higher contributions. Certain employers also offer nonqualified savings accounts that allow you to defer income in excess of the limits for the qualified plans listed here, but they add different risks.

Besides employer-sponsored plans, annuities and life insurance can also offer tax advantages, but most savers should proceed cautiously. Annuities provide tax deferral, but lack the upfront tax benefit that makes other tax-deferred accounts so appealing. Also, distributions from annuities are taxed at ordinary income tax rates, so if your tax rate is expected to remain high through retirement, you effectively allow the government to take a higher share of your profits than would be the case in a taxable account. If your income tax rate is expected to drop substantially in retirement, certain annuities can be effective savings vehicles once you have exhausted your other options. In many cases, the higher costs of life insurance products outweigh their tax benefits.

If you want to funnel more money into a tax-free account, you might consider converting a portion of your tax-deferred retirement accounts to a Roth IRA. You will have to pay tax on the income at the time of the conversion, but if you expect your tax rate to remain the same or increase in the future, it may be profitable to shift some funds to a Roth. Finally, if you plan to use any of your savings to fund education expenses for a child or grandchild, you might consider funding a Section 529 college savings account. The investments in such accounts grow tax-deferred, and any distributions used for qualified education expenses are tax-free.

How To Spend Down Retirement Accounts

The order in which you withdraw assets during retirement is just as important as the choice of which accounts to fund. By mindfully selecting which account you withdraw from each year, you can lower what you pay in taxes.

The first assets you spend should typically come from your taxable accounts. However, in a low-income year, when your income tax rate may be lower, it may make sense to pull some funds from a tax-deferred account. In some cases, you can take taxable distributions without generating any tax liability at all. Spending from tax-deferred accounts may also make sense if your taxable accounts have highly appreciated securities that you plan to hold until death. Run tax projections each year to weigh the benefits of withdrawing from a taxable or a tax-deferred account.

Aim to keep assets in your Roth accounts for as long as you can, allowing the investments to continue to grow tax-free while you deplete other assets that generate tax liability.

For most retirees, no two years will look alike. More important, there is no way to know decades in advance what a given person’s tax situation will be throughout retirement. As with any long-term investment plan, it is essential to create a strategy that is flexible and can work even when circumstances change. By taking care to diversify the tax character of your accounts, you build in choices that will allow you to adapt to a variety of financial situations much more easily and, ultimately, to preserve more of your diligently saved retirement funds.

Tax Concepts and Considerations of Municipal Bonds

Bonds are available in both taxable and tax-exempt formats and there are tax concepts to consider when a person is investing in bonds. Each type of bond, whether tax-exempt or not, has different tax aspects. Tax-exempt municipal bonds and taxable bonds are discussed, explaining how some of the tax rules work for these investments and their investment yields.

Acquisition of Bonds

When purchasing tax-exempt municipal bonds at face value or par, there are no instant tax consequences. When the bond is acquired between interest payment dates, the buyer pays the seller interest that has accrued since the last payment date. The interest paid in advance to the seller is treated as the cost of the investment and is treated basically as a return of some the initial investment when the interest is paid.

Bond Premium Amortization

When tax-exempt municipal bonds are purchased at a premium, the premium is amortized for the duration of the bond term. The effect of this is to decrease the cost of the investment in the bond on a pro rata basis. Thus, holding the bond to maturity means no loss recognized when the bond is paid off.

Interest Excluded From Taxable Income

Normally, tax-exempt municipal bond interest is not added to income for tax purposes (although, the interest may be taxable under alternative minimum tax rules). Also note, municipal bonds usually pay lower interest rates as compared to similar bonds that are taxable.

When comparing taxable investments to tax-free investments, the amount of interest included in income is not the most important issue. What is important is the after-tax yield. For tax-exempt municipal bonds, the after-tax yield is usually equivalent to the pre-tax yield. On the other hand, a taxable bond’s after-tax yield will be based on the amount of interest remaining after deducting the corresponding amount of income tax expense associated with the interest earned on a taxable bond.

The after tax return of a taxable bond depends on a person’s effective tax bracket. In general, tax-free bonds are more appealing to taxpayers in higher brackets; the benefit of not including interest earned in their taxable income is greater. In contrast for taxpayers in lower brackets, the tax benefit is less substantial. Even though municipal bond interest is not taxable, the amount of tax-exempt interest is reported on the return. Tax-free interest is used to calculate the amount social security benefits that are taxable. Tax-free interest also affects the computation of alternative minimum tax and the earned income credit.

Tax-Free Interest is excluded from 3.8% NIIT

Tax-exempt municipal bonds interest is also exempt from the 3.8% net investment income tax (NIIT). The NIIT is compulsory on the investment income of individuals whose adjusted gross (AGI) is in excess of:

· $250,000 for filing status Married Filing Joint and Qualifying Widower,

· $125,000 for filing status Married Filing Separate, and

· $200,000 filing status Single and Head of Household.

Tax Advantaged Accounts

Purchasing municipal bonds in your regular IRA, SEP, or §401(k) is a no-no. These accounts grow tax free and when withdrawals are made, the amount withdrawn is taxable. Thus, if you desire fixed income obligations in a tax advantaged account consider taxable bonds or similar income securities.

Alternative Minimum Tax Considerations

Interest on municipal bonds is usually not included in income for regular federal income taxes. Interest earned on certain municipal bonds called “private activity bonds” is included in the calculation of alternative minimum tax (AMT). The AMT is a parallel tax system established to make sure that taxpayers pay a minimum amount of taxes. The intention of creating AMT was to prevent people from getting to many tax breaks, for example tax-free interest. The tax breaks are added back into income and cause some people lose tax breaks and pay taxes.

Effects of Tax-Free Interest on Taxability of Social Security

A percentage of social security benefits are taxable when other income besides social security benefits surpasses certain amounts. For this purpose, the amount of taxable social security benefits adds tax-exempt interest into the amount of other income received besides social security benefits to determine the amount of taxable social security benefits. Consequently, if you receive social security benefits, tax-free interest could increase the amount of tax paid on social security benefits.

Effects of Tax-Free Interest on the Calculation of Earned Income Tax Credit

When a taxpayer is otherwise qualified to receive the earned income tax credit, the credit is lost completely when the taxpayer has more than $3,400 (2015) of “disqualified income.” Disqualified Income generally is investment income like dividends, interest -income, and tax-exempt income. Thus, having municipal bond interest in excess of $3,400 causes a taxpayer to lose the credit. However, an individual qualified for the earned income tax credit is in a lower tax bracket and an investment in municipal bonds would yield a lower after tax return as compared to taxable bonds.

A Bond Sale or Redemption

Selling a bond before maturity or redemption has the same tax consequences as a taxable bond. Gains from sale are taxable. Losses are deducted from other gains; and losses in excess of gains are allowed up to $3,000, the remaining losses are carried over to future years.

Selling Bonds Purchased At a Discount

Bonds acquired with “market discount”, have special calculations then they are sold. The discount that accrued during the period maybe treated as ordinary income.

Mutual Funds

Some investors want professionals to manage a diversified portfolio of municipal bonds, to lower the default risk on any particular bond issue. There are certain mutual funds that invest in tax-free municipals and manage them.

We hope this article was helpful. This article is an example for purposes of illustration only and is intended as a general resource, not a recommendation.

Need assistance with above rules? Have any other questions.

Accountant Pompano Beach

Ultimate Practical Tax Lawyer Secrets to Tax Audit Survival

CRA Income Tax Audit – Toronto Tax Lawyer Introduction

As Toronto tax lawyers we deal with CRA audits and auditors on a daily basis. So what is a tax audit? This article will explain what you can expect to happen if you are audited for taxes.

The Canadian income tax system is based on self assessment. In other words it is up to every Canadian taxpayer to fully and properly report their total income from all sources on their annual T1 or T2 income tax return. The Canada Revenue Agency performs tax audits and issues income tax assessments to ensure that the self-assessment income tax system continues to work properly. While most Canadians are truthful on their tax returns, there are some who are not. CRA is looking for errors or disputable positions or deliberate misstatements on tax returns that have been filed.

What is a Tax Audit?

An income tax audit is an examination of a taxpayer’s returns and supporting records to make sure that income and expenses have been properly reported and are supported by accounting records and receipts. The CRA tax auditor will ask to see the individual or corporate books and records and bank account and receipts for expenses. A corporation will normally have to provide its minute book to support any dividends or bonuses. There may be questionnaires to be filled out. Any information that is wrong, even if due to an error, will be used against the taxpayer.

Most audits are done to ensure compliance with the Income Tax Act for income or payroll deductions or under the Excise Tax Act for GST/HST.

Canadian Tax Audit Procedures

CRA auditors will often search for relevant information on the Internet, and a taxpayer’s web site or other sources located on Google might contradict information the taxpayer provides to the auditor. This information will then be used for further enquiries possibly including 3rd party requests for information. Furthermore open social media accounts are publicly accessible, and CRA auditors will gather this data from taxpayer social media accounts to build a case against a taxpayer. CRA officials have publicly discussed using taxpayer’s social media accounts in this way. If taxpayer lifestyle and reported income don’t match up the CRA tax auditor may decide to look into the taxpayer’s situation to see what’s actually going on.

CRA’s practice on income tax audits is to do a GST (and HST) compliance review; if problems are found, the matter is normally forwarded to a GST/HST auditor for a full GST/HST audit. Similarly, an income tax compliance review is often done during GST/HST audits. Combined income tax and GST/HST audits were discontinued in July 2010. These compliance reviews are not always carried out and sometimes income tax audits may miss large GST/HST problems and vice versa.

CRA Audit Statistics

CRA issues an annual report to Parliament. The latest one was released in January 2016. The audit statistics from CRA Annual Report 2014-2015 provide less detailed information than for the previous year.

For small & medium enterprises no statistics were given. CRA reports that they reviewed 12,981 international and large business files and 9,440 aggressive tax planning files that resulted in identifying $1.4 billion in fiscal impact. For international and large business files CRA audited 6,540 income tax and GST/HST underground economy files and identified over $448 million in fiscal impact. In all cases there were fewer audits in 2014/15 that the previous year. Presumably this reflects the results of budget changes.

Reasons for Tax Audit

CRA may choose to audit a taxpayer for several reasons. Amongst them are:

  • Industry audit projects
  • Random selection
  • Third party tips
  • Past history of non-compliance
  • Comparison of information on returns to information received from third-party sources – in other words are all T-slips reported

Since 2011 CRA has been auditing high net worth individuals and families, sending questionnaires asking for information about all companies, trusts, etc. that they control.

CRA has also been concentrating additional audit resources on the underground economy in an attempt to deter unreported cash sales.

What is the Tax Auditor Looking For?

The focus of the tax audit is to find errors in tax returns. Here are some examples of typical issues that may arise in a tax audit that would cause a taxpayer to receive a tax assessment at the end of the tax audit and that could result in penalties or a referral for a tax evasion investigation:

  • Overstated Expenses
  • Overstated Deductions
  • Over claimed Income Tax Credits
  • Under reported or unreported Earnings
  • Unreported cash sales
  • Unreported internet income
  • Unreported offshore income
  • Unreported offshore assets
  • Credits, such as for charitable donations, that are not supported by receipts
  • Personal expenses deducted for business
  • Shareholder loans not repaid within 2 corporate year ends

Right of CRA to Audit and CRA Audit Policies

Section 231.1 of the Income Tax Act gives CRA the statutory ability to carry out audits. In particular it entitles auditors to request and examine documents including computer records. Section 231.2 is a more formal provision whereby a “demand” or “requirement” is issued, but it need not be used by a tax auditor in the normal course where s.231.1 suffices.

The CRA can choose to audit anyone, but case law has held that such discretion does not permit a vexatious audit made for capricious reasons.

The Canada Revenue Agency has an internal policy in CRA Audit Manual §9.12.3 that audits should normally be limited to “one plus one” years that is to say the most recent year for which a return has been filed and assessed, plus one year back, with limited exceptions. This policy can be pointed out to a tax auditor to try to limit the scope of audit requests, but it has no legal effect and cannot be used in court to challenge a tax assessment that has been issued. Of course this rule of one plus one years does not apply in the case where CRA suspects unreported income. They will typically look at three years, and in some cases even more than 3 years.

In theory, the CRA has no discretion in applying the Act and must “follow it absolutely” by issuing a tax assessment for all otaxes wing. The reality is that in practice tax auditors have wide discretion not to assess an amount, however once it is correctly assessed; a Tax Appeals Officer or Tax Court judge will have no power to cancel it on grounds of equity, fairness or compassion.

Tax Audit Assistance from Toronto Tax Lawyer

Our top Toronto tax lawyers fight CRA tax auditors every day. A taxpayer has the right to professional representation at all times. This is specifically provided for in right 15 of the Taxpayer Bill of Rights which says “You can choose a person to represent you and to get advice about your tax and benefit affairs. Once you authorize us to deal with this person, we can discuss your situation with your representative.” A taxpayer should never meet with a CRA auditor without a professional Canadian tax lawyer present. Any information that is wrong, even if due to an error, will be used against the taxpayer. The auditor will also take notes and may misunderstand what the taxpayer has said or may wrongly record responses. An Ontario tax lawyer will have his or her own notes to contradict any auditor errors. Contact our Toronto tax law firm for tax help as soon as a CRA tax auditor contacts you.

Founding lawyer, David Rotfleisch is an expert in the realm of income tax law.You might say that income tax is David’s passion for David is not only a lawyer, he is a chartered professional accountant. He has helped start-up businesses, resident and non-resident business owners and corporations with their tax affairs, and over the years, he has assisted numerous corporations and individuals with simple and complex tax and estate planning matters as well as tax amnesty and tax litigation issues.

We are Toronto based tax lawyers with more than 25 years of experience. We deal with all tax problems of the Canadian citizens and find out the perfect solution for them in a quick,responsive and efficient way. We fight CRA daily. Share your income tax problems with us and sleep at night.

Maritime Taxes: Saving Money On The Water

The siren call of boat ownership is easy to understand, here in South Florida. On a hot summer day, or even a crisp winter afternoon, getting out on the water for some sailing, fishing, snorkeling or water skiing can seem like the perfect reason to take the plunge.

Florida, and in particular the Greater Fort Lauderdale area where I live and work, is a major center for the motor yacht and boating industry. In South Florida, about 136,000 people currently work in the industry. According to industry figures for 2014, 19 percent of the over 30,000 boats sold in the U.S. that year were sold in Florida.

If you are ready to invest in a boat of your own, whether a modest fishing boat or a high-end yacht, it is worthwhile to pause and consider the tax implications, wherever you may live. Depending on the ways in which you intend to use your new watercraft, that impact could be minimal, or it could significantly change your overall financial picture.

Taxing Boat Sales

As with any big-ticket purchase, you should keep sales tax in mind when you are ready to buy your vessel of choice. There is no federal vessel tax, and federal luxury tax was repealed in the 1990s, so Uncle Sam does not take any particular interest in whether or not you choose to buy a boat. The states, however, want their cut. Every state is different, so be sure to take the time to understand any particular quirks in state law before you buy.

In Florida, for instance, boats are subject to the state sales tax rate of 6 percent, in addition to any local taxes. However, as of 2010 Florida has capped this tax, limiting it to the first $300,000 of a boat’s purchase price. Thus, under current law, Florida will not collect more than $18,000 in sales tax on your new vessel. In addition, many Florida counties impose a discretionary sales surtax, which can apply to the first $5,000 of the purchase price. These sales tax caps make buying a high-end boat more attractive in Florida.

The Florida Legislature’s revenue estimating committee projected in 2010 that the tax cap would cost the state as much as $1.4 million in the first year. Instead, tax collections on yacht sales in the state rose more than $13 million in that time. Buyers who previously spent large sums to form offshore companies in order to skirt the state tax found it cheaper and easier to simply pay the Florida tax outright. So before you buy a boat, consider whether you can get a better deal by buying and berthing it in another state.

The cap on boat sales tax was so powerful that other states are competing by passing caps of their own. Recently, Maryland, New Jersey and New York all passed or are considering passing laws to cap the tax on boat sales. Depending on your politics, you may consider this an unnecessary tax break for the wealthy boat-buying class, but based on the increase in tax revenue after Florida’s cap went into effect, you can also see how lowering taxes and state competition can sometimes lead to long-term economic benefits. More boat sales in Florida lead to more employment and growth in marine-related industries in the region.

For whatever sales tax you do pay on your boat purchase, you may be able to realize some benefit when filing your federal income taxes. Assuming you itemize your deductions, you can deduct local sales tax in lieu of claiming state and local income taxes. Especially in states – like Florida – that do not levy a personal income tax, this can represent a significant deduction. The main calculation of the general sales tax deduction is based on your adjusted gross income, but you can add sales tax paid specifically on a car or boat purchase to that amount.

Make sure you also understand how a state’s use tax may impact you. For the typical recreational vessel, use tax will not matter, because sales and use tax are mutually exclusive – if you pay sales tax on a transaction, you cannot also owe use tax. That said, if you plan to use a watercraft primarily in a different state than the one where it was purchased, it is worth taking the time to make sure you understand your home state’s rules and that your documentation is in order so you do not end up a target for overzealous state tax authorities.

You should also educate yourself on state and local taxes related to a watercraft which may apply on an annual or ongoing basis. Certain states and local authorities levy personal property taxes annually on boats docked within their jurisdictions.

On the other hand, some states offer particular tax breaks to boat owners. For example, last year Florida passed a law limiting the sales tax on boat repairs to no more than $60,000, or the first $1 million of repair costs. Like the sales tax cap on boat purchases, the law is intended to allow Florida to maintain its status as a leader in the marine industry. The hope is that the cap on boat repair sales tax will attract and retain repair and refit business for luxury yachts and other high-end boats in the state, thereby increasing revenue and employment, bolstering the local economy. If you own a yacht in a high-tax state, it could make sense to cruise it down to Florida for major repair work to save on taxes. Some states even offer a tax credit on fuel used for recreational boating. Yes, even the boating industry has a strong lobby group to push state legislators for tax breaks.

Living On Your Boat

While it makes sense to think of your vessel in the same way you might think of a car or recreational vehicle, there is another way to characterize it. In some cases, a boat can plausibly serve as a second home, meaning it can offer deductible home loan interest. In order to qualify, the vessel must include cooking, sleeping and toilet facilities; do not try to convince the Internal Revenue Service that you live on your jet ski.

There are a few other caveats. The deduction is on mortgage interest secured by the residence, so the deduction will not affect you if you bought your boat outright or used some personal line of credit, such as a credit card. Also, if you are already deducting interest on a second home, you cannot deduct both it and the boat loan interest in the same year, though you may switch between them from year to year if you wish.

A boat may even be your primary residence. Technically, as long as it meets the bed, bathroom and kitchen (or rather galley) test, you can declare your boat to be your main home. Note that if you use your boat for business, as I’ll discuss in the next section, you must divide your home between the part that is your primary residence and the part that is used to generate income. If your boat is your primary residence and it does not dock in the same port regularly, you may face a tricky tax domicile situation too.

Your Boat As A Business

Many boat owners use their boats to earn income, either on the side or as their main business. Depending on your situation, you may decide to use your vessel as a fishing charter, to run scuba or snorkeling tours, or to serve as a private ferry. As with a land-bound venture, you will need to take care to steer clear of the IRS’ hobby-loss rules by proving your genuine intention to make a profit, rather than just cover the costs of your time out on the water.

The benefit of establishing your activities as a genuine business is the ability to write off the boat’s depreciation, maintenance, equipment and fuel costs. You may not want to devote your boat exclusively to chartering; if not, you will need to keep track of the time and costs spent on private and business pursuits. Either way, you should always keep good business records and institute an accounting system to track your business activity.

As with other forms of self-employment, you will be responsible for income taxes and self-employment taxes. Remember that you may be subject to estimated income tax, which is due quarterly. Many boat owners choose to transfer their boat ownership to a limited liability company (LLC) for liability protection, but since this is a pass-through entity for tax purposes, it will not generally make much difference to your personal tax situation. If you are not used to running your own business, it may make sense to consult a tax professional or a Certified Financial Planner™ to make certain you keep up with your personal and business tax responsibilities.

If your boat business involves crossing state lines, you may need to be particularly careful about documenting the way income is sourced. Many people run up against the complications of conducting business in multiple states, and the water adds another complication. However, under a specific federal law (Chapter 46, U.S.C. Sec 11108(b)), working on navigable waters in the jurisdiction of more than one state is not sufficient to subject you to the states’ income tax rules. For example, if you live in Florida but work as a crewman on a vessel that operates in or passes through waterways of other states, only Florida – your state of residency – can impose its income tax laws (or lack thereof, since Florida has no state personal income tax). This law is particularly important for crewmembers on dredging vessels, which may operate in multiple states’ waterways (up the Mississippi river, for instance).

If you intend to find yourself operating in more than one state regularly, it may be best to consult a tax professional at the outset to understand what factors could affect your taxes. Where and how often a vessel docks and how much work is conducted on or connected to land can make a difference.

Some boat owners have no interest in running a small business, but would still like to offset the cost of owning a watercraft. An alternative strategy is to place the boat in charter with a reputable charter company. In such an arrangement, you typically retain ownership of the vessel, while the company assists you in managing what is essentially a rental business. Before you go this route, you will want to perform thorough due diligence and make sure your state’s business laws support such an arrangement, and you should understand your potential liability exposure.

What if your boat is also your office? The rules will be the same as for a home office ashore. The IRS primarily will consider whether you use your boat office exclusively and regularly for business purposes. For a boat-based office, the tricky requirement is usually the exclusive use test, because boats often have multi-purpose rooms. The IRS wants to see that you maintain a separate room or dedicated workspace that you use exclusively for business purposes.

If you are an employee and you use a part of your boat for business purposes, you may qualify for a deduction for its business use, but in addition to the exclusive and regular use tests, the boat office must also be for the convenience of your employer. You also must not rent any part of your boat to your employer and use the rented portion to perform services as an employee for that employer. If the use of the boat office is merely appropriate and helpful, you cannot deduct expenses for the business use of your boat office.

In many geographic regions it is only practical to use boats seasonally; note that an office aboard a vessel qualifies only for deductions during the time of use. IRS rules prohibit deducting office expenses aboard the boat during the period when you are not using the boat office for business purposes, or when the boat is in dry dock or storage.

A boat of your own can serve as a fun way to enjoy time on the water, a secondary or primary source of income, or even an unconventional place to call home. But besides the high costs of buying and maintaining a vessel, don’t overlook the tax considerations when deciding whether to answer the call of the open water.

Are Your Prepared for These Year End Income Tax Issues?

Over the course of the year, I’m sure you’ve noticed the ridiculous way our Congress has acted to update our tax laws. By including tax code provisions in a highway bill, a mass transit bill, and a trade package bill- plus within the Bipartisan Budget Act and the PATH (Protecting Americans from Tax Hikes) Acts. (Those last two were, indeed, logical places to regulate taxes.)

There is a chance that the lame duck Congressional session may act on some tax regulations, but given that these folks work about 1 day a week- and then complain how many lazy folks are out across the US not entering the workforce (that is the pot calling the kettle black)- I am not sanguine they will. So, unless they do- this will be the last year that mortgage insurance will be deductible and foreclosed home debt will not be a taxable situation, among a few other items that expire this calendar year.

But, I figured it would be helpful if I combined all these changes into a coherent mass (which our legislators clearly have not), so you can be prepared for the 2016 tax season. (Remember, you file your taxes for 2016 by April 2017. Oh- and if you are a business, the odds are the date your taxes are due, also changed. More on that below.)

Students and Teachers (PATH Act provisions)

Students got a permanent change for deductibility of tuition via the American Opportunity Tax Credit. This provides up to $ 2500 of tax credit for lower-income filers for the first four years of higher education (with a possibility of 40% of the unused credit being received as a refund- if no other taxes are owed). As long as the students are enrolled at least half time for one term of the year and not convicted of drug violations. The real change is that filers must include the EIN of the college or university involved- and demonstrate that they paid the tuition and fees they claim- not what the institutions may list on the 1098-T form.

On the other hand, the tuition deduction for other students will expire at the end of this year. Oh, and that generous (sic) deduction teachers get for buying supplies for their students that schools don’t supply is now permanent- all $ 250 of it. (Most teachers spend at least twice that!)

Pensions and IRA

Folks older than 70.5 years of age no longer have to rush to transfer their IRA (or portions thereof) to charity, because that provision is permanent. (PATH) Please note that the IRS demands that these transfers not be rollovers. One must employ a trustee to transfer the funds; and that trustee cannot hand you the funds to deliver to the charity. If they do, you lose the exemption. No surprises I am sure when I remind you that there must be a contemporaneous acknowledgement (that means a timely receipt) from the charity for that deductible donation or transfer.

Heirs and Estates

While still in the wrong venue, the Highway Bill did fix a big problem. Folks (or entities) that inherit assets from an estate are now required to use the basis filed in the 706 form for their own calculations. (Just so you know, the rules stipulate that estates can value items as per the date of death, or by alternate choice 9 months after that date. Too many “cheaters” would use a different basis for the property they inherited, thereby cheating the tax authorities with alternative valuations.)

To keep this rule in place, executors are now required to stipulate (i.e., file for 8971 and Schedule A of the 706) said value to all heirs and to the IRS. Which means anyone who inherits property- and thought they didn’t need to file Form 706 because the value of the estate was below the threshold for Estate Tax better reconsider. Otherwise, the heirs may be hit with a penalty for using the wrong basis for that inherited asset when they dispose of same.

Why? Because if a 706 form is never filed, the basis of all assets inherited is now defined as ZERO!!!!! It gets worse. Because if an asset were omitted from Form 706, the basis of that property is now determined to also be ZERO. (Unless the statute of limitations is still opened, when an Amended 706 can be filed to correct this omission.)

Another kicker. If the 706 form is filed LATE, the basis of all assets that should have been included are also set at ZERO. Some tax advisors feel this one little provision could be challenged in court. But, let’s just be prudent and file all those 706 Estate Tax returns in a timely fashion. (Filing a 706 when the estate value is below the filing threshold is called a Protective 706 Filing; we’ve been doing those for years. And, we strenuously examine the assets often to the consternation of the heirs- to ensure that all the non-worthless assets are included. You know, that 36 diamond tennis bracelet your grandma promised you would inherit when you turned 16.)

Oh, yeah. Another really big kicker for this little item. Under IRC 6501, the IRS has three years to catch cheaters who misstate certain items (like income taxes [except for continuing fraud], employment taxes, excise taxes, and for this provision- estate taxes and the results therefrom). No more. If an asset from an estate is misstated so that it can affect more than 25% of the gross income on a tax return will now have a SIX year statute of limitation.

Mileage Rates

Not surprisingly, the mileage rates for 2016 are lower than they were last year. Business mileage is now deducted as 54 cents a mile; driving for reasons that are medical or moving are only worth 19 cents each. When we drive to help a charity, we only get 14 cents a mile.

As is normally true, we have no clue what those rates will be for 2017. The IRS normally prepares those well into the calendar year.

Real Estate

The PATH ACT made permanent the ability of taxpayers to contribute real property to qualified conservation charities.

Health and Health Insurance

The Highway Bill (yup) came up with a bouquet of flowers for our veterans and folks currently serving in the military. No longer will they be unable to contribute or use HSA (Health Savings Accounts) should they receive VA or armed service benefits.

Along that same vein, the Highway Bill enabled all those who purchase- or are provided by their employers- high deductible insurances (about $ 1500 for a single person) to use HSAs, too.

Oh, and assuming Obamacare is not overturned, there is a permanent exemption from penalties for those receiving VA or TriCare Health Benefits. (For employers, the Highway Bill also exempts all such employees from being included in determining the 50 employee (full-time or equivalent) threshold provisions.)

Employers

There were more than a few changes for employers. More than the exemption for the VA and armed service personnel from inclusion in Obamacare provisions mentioned above.

Like ALL 1099s and W-2 are now due by 31 January. That’s a big change for many folks who barely get their stuff together to file 1099’s. It means that companies need to contact their tax professionals really early- to let them verify that all relevant contractors and consultants receive those 1099s on time. Because the penalties have also increased.

The Work Opportunity Credit has been extended through 2019. This applies to Veterans (which is why you keep hearing Comcast advertising its commitment to hire some 10,000 veterans over the next few years- they’re no dummies). Other targeted groups include what are termed those receiving Temporary Assistance for Needy Families (TANF), SNAP (what used to be termed Food Stamp) recipients, ex-felons, and some of those living in “empowerment zones”.

Families and Individuals

The PATH ACt made the enhanced child tax credit (up to $ 1000, income dependent) a permanent provision of the code. As well as the Earned Income Tax Credit provisions that were to expire.

Social Security taxes are not going up per se- but the income basis upon which one pays them is. For the last two years, there was a tax holiday for all wage income (or self-employed income) that exceeded $ 118,500. Next year (2017), the taxes will be collected for totals of up to $ 127,200.

If an employee is working overseas and has income and/or a housing allowance, the exclusion provisions have also changed. For 2016, foreign income of $ 101,300 could be excluded from taxation, as could housing benefits that were $ 16,208 or less. Starting 2017, those exclusions become $ 102,100 and $ 16,336, respectively.

There also is further clarification of these foreign exclusions. In particular, these will affect those in the merchant marine or working aboard cruise lines. Because the IRS now holds that when one is in a foreign port, then one is able to claim foreign income. But… when someone operates in international waters, that is NOT a foreign country. That income must be computed (by the number of days one is on said waters) and is not excludable!

Individuals, Businesses, Trusts, Non-Profits that have Foreign Accounts

Some big changes affect those who must file those FBARs (Foreign Bank and Financial Accounts). It used to be you had to report any holdings in a bank, stock account, commodities or future accounts, mutual funds, or [pay attention to this one] poker, gambling or gaming site account that was not a US domicile by 30 June. (This also means a foreign insurance policy that has a cash value or foreign retirement accounts [including inheritances] is a foreign account.) It also covers recent immigrants to the US! These filings are due at the same time as your income tax return. But, while there never was an extension possible for these forms, now there is – for the same six months that obtains for your personal tax filings.

A foreign account does not mean that using the Royal Bank of Scotland to house funds in New York City; but having a Citicorp account that is based in Jerusalem or London does. The critical consideration is where the local branch is situated, where the account was opened. By the way, accessing foreign funds via PayPal means you have a foreign account.

The FBAR filing uses Form 114 and must be now filed electronically. The requirement to file applies to all taxable entities (individuals and businesses) that have $ 10,000 or more of value on any given day during the tax year. And, the conversion rate for said value is no longer allowed to be daily- but determined by the value on the last day of the tax year.

There is a new interpretation, too. The requirement to file applies not just to the account owner(s), but to anyone with signature authority. So, that means people like me that maintain client accounts overseas will now have to file these forms, because I can issue checks on those accounts. (I am not responsible for about 100 of them where I write the checks for the clients- but have no signature authority.) It also means employees of corporations or businesses or estates that have foreign funds and have signature authority must also file Form 114.

All business entities (and trusts and non-profits) should recognize that all entities – and individuals who work for or at those entities- that have signature authority for a foreign bank account, stock account, gaming or gambling account are subject to these provisions. In other words, all foreign money holdings may subject employees, not just officers of the institutions, to these provisions.

Oh. The IRS also requires those foreign entities where you may or may not have money to file Form 8938, a FATCA (Foreign Account Tax Compliance Act) filing. This covers those financial accounts, stocks, securities, contracts, interests- anything that exceeds the filing threshold. These rules also apply to American entities (individuals, businesses, trusts, etc. that have such interests in excess of the filing threshold! (If one resides in the US, those thresholds are $ 50K for individuals, $ 75$ for married folks on the last day of the year- or $ 100K and $ 150K at any time during the tax year. Those numbers increase by a factor of 4 if one doesn’t reside in the US; the thresholds are $ 200K, $ 300K, $ 400K, and $ 600K, respectively.)

Businesses

The PATH Act changed the 179 (the capital purchases write-off provisions) Election. For good. The maximum Section 179 write-off is now permanent. (It had been extended for a year or two each time Congress had made a change for a while.) That maximum is also to be adjusted for inflation starting this year, which is why it is now $ 510,000. Moreover, there is a phaseout when the amount of new capitalized property exceeds $ 2.03 million, but not to zero.

Real Estate

For real estate purchases, the maximum Section 179 exclusion is now also $ 500K. (Last year, it was capped at $ 250K.) This includes HVAC (heating, ventilation, and air conditioning), which is a new change. Any recapture of this credit (due to an early sale) is now considered subject to ordinary income taxes.

The time to depreciate real estate is now 15 years for qualified leasehold improvements, restaurants, and retail improvements. Bonus depreciation is also allowed for the first half of said improvement value (through 2017), decreasing in 2018 to only 40%, 30% in 2019 and removed completely by 2020. The PATH Act also let bonus depreciation apply to 39 year property (for improvements that were already in service by the entity).

Automobiles (Luxury)

The depreciation limits for vehicles is limited to $ 3160 or 20% of the basis in 2016. However, this year one can write off up to $ 8000 in bonus deprecation (which is reduced to $ 6400 in 2018, $ 4800 in 2019 and then removed forever by 2020) for new (not used) automobiles. Of course, these numbers apply only to vehicles that are used completely for business. There is a reduction for vehicle use that is not fully attributed to business usage.

Partnerships

The Bipartisan Budget Act (the one that taxes would normally be addressed) has brought a sea change to the way partnerships will be treated, should the IRS find problems with their tax submissions. The changes do not take effect for a few years- but the time to address the changes is really now.

Basically, the Act stipulates that any change that comes about by an audit are to be collected directly from the partnership- unless the partnership elects out of TEFRA (Tax Equity and Fiscal Responsibility Act of 1982). So, it means that partnership formation, operations, new partner admissions, etc. will all have to be reconsidered.

What changed is this- the partnership can decide to accept an IRS decision that the underpayment is due from the partnership itself or it can elect to have that decision divided up among the partners, according to their percentage ownership or liability percentage. Most advisors are telling partnerships to elect the latter process. If the partnership does not so choose, then the IRS will assess the partnership at the highest tax rate allowed- 39.6%. Of course, if the partnership can prove (to the satisfaction of the IRS) that a lower rate is appropriate, based upon the individual tax rates of the partners, then a lower rate may be allowed. (Don’t bank on the IRS doing so.) However, this underpayment will not be allowed to change the basis of each of the partner’s interests, if the partnership is taxes for the liability.

If the partnership pushes the issues down to the partner level, then each partner is assessed for the tax at its own rate. And, the partnership can issue an adjusted (amended) K-1 for the IRS revisions that will change the basis and avoid the double taxation possibility. The partnership has 45 days from the date of the IRS notice of change to make this election.

There is another change that affects partnerships- the PAL (passive active loss) issue. Why? Because most partners and partnerships do not maintain pristine time records. (This also affects real estate rentals that are reported on Schedule E, page 1.) There are various definitions that set the PAL issues- for real estate professionals it is a minimum of 750 hours of work a year. The IRS has allowed other partnerships to use different designations, such as 500 hours, or the fact that a particular partner does all the work (even if less than 500 hours), or even when a partner spends 100 hours or more on the partnership and no one else does more.

But, the rules to prove how much participation are gelling. One can use a record of cell phone call records, eMails, or credit card charges. Travel itineraries and receipts can prove how much participation was involved. Even affidavits from customers and clients can be used to prove the time one participated in the venture.

Payments Due

The IRS has been starved to death for years by Congress. Partly because one party was angry that the IRS was not automatically granting those “social welfare” organizations (read as political collections and donation farms) tax exemptions without scrutiny. Partly because the IRS is responsible for collecting the penalties for those who don’t comply with Obamacare. (Hoping that this lack of funds would make it harder for them to do so.)

But, in my humble opinion, the solution Congress came up with sucks. The IRS has now been authorized to hire those bottom feeders- the outside collection agents, that harass and subject folks to all sorts of intimidation. The logic behind this choice? After all, folks who owe the IRS must be the scum of the earth. (Of course, no one ever considers the fact that the IRS makes mistakes, chooses random numbers to assess non-filing taxpayers who may actually owe nothing, etc.)

Many clients fall short of having sufficient funds to pay their taxes when due. This entails the taxpayer submitting a form 9465 (Installment Agreement Request). These must be automatically approved if the taxpayer [individual] owes (or will owe) the IRS $ 50,000 or less, with the addition of this request- and all tax forms have been timely submitted. (Businesses are limited to a $ 25,000 maximum, with the same provisos.) However, the fees involved to have the IRS process the request have been increased to $ 120, unless the taxpayer agrees to have the IRS zap their bank account automatically each month. Then, the fees are reduced to $ 52. (The IRS has way too many taxpayers “forgetting” to make timely payments. This is a way to incur fewer manpower issues for the service.) However, no matter how the payment is to be processed by the IRS, all low-income taxpayers (a family of 4, with $60K or less in income) won’t have to pay more than $ 43 to institute a payment plan.

The biggest issue? Any taxpayer who is not in compliance with IRS code, who has no installment agreement in place, and owes $ 50,000 in taxes, penalties, and interest can find his passport revoked IMMEDIATELY. (If one is not yet issued, don’t expect the Department of State to issue one, either.)

Filing Dates

Individuals

There has been no change in the due date for 1040 filing, in that it is still due on 15 April (or the next business day, should the 15th fall on a weekend or legal holiday). Unless you can prove you were out of the country on 15 April- then you have the right to extend the filing date to 15 June. Or, you filed an extension request- that gives you until 15 October (with the same proviso for when it falls on a weekend or legal holiday).

Businesses

Here’s where the big changes arrive. And, it is about time. Because too many pass-through entities have been screwing over their partners, their stockholders by delaying their filing. Oh, sure, they may pay a penalty, but that doesn’t help the multitudes who can’t file their taxes in a timely fashion due to the lassitude of these entities.

So, from now on, all pass through entities- those are partnerships, LLCs, and S entities must no file their tax returns by the 15th day of the 3rd month after the end of their tax year. Recognize that the IRS allows companies that have “good” reasons to not use a natural year (i.e., 1 January to 31 December) to chose another month to end their tax year. But, for most entities, the due date will now be 15 March. Which gives the partners or the stockholders a month to finish their own tax returns. (Firms that operate on the US Government year, which ends 30 September, for example, must file their taxes by 15 November.)

Regular Corporations (C entities) no longer have to file by the 15th day of the 3rd month, but now have until the 4th month. So, for those companies operating on a natural year basis, the due date has been extended (permanently) from 15 March to 15 April. (A similar 15th day of the 4th month after year-end applies for those not operating on a natural year basis.)

Business, Trusts, Non-Profits, and Pension Plan Extensions

There is one more change for C corporations. Their extension is no longer 6 months long- but 5 months. In other words, before when they had to file by 15 March, but could extend the due date until 15 September… still have that same final extended due date, regardless that the original filing date is now 15 April.

Partnerships and S entities still have a 6 month extension- which also falls (for those who use a natural year) on 15 September.

Trusts and Estates of the Deceased file form 1041. The only extension request provided 5 months beyond the due date. Now, the due date is 5.5 months. That means the due date for filing is 15 April, but an extension means the due date can be 30 September.

Non-Profit entities file form 990 on 15 May- or the 15th day of the 5th month after the end of their fiscal year. Extensions used to be provided for 3 months; they now have more time- six month extensions are the new rules.

Employee Benefit Plans (Pension Plans, 401(k), welfare plans) must file their tax returns with the IRS by the last day of the 7th month after their year end. (For natural year plans, that means 31 July). Before the plans could extend that deadline by 2.5 months; now the rule provides for an additional month to 3.5 months.

Late Filing Penalties

The minimum penalty for filing late (more than 60 days) has been increased from $ 135 to $ 205. Except in certain cases, that penalty can be reduced to the amount of tax owed, which ever is smaller. (By 2017, the penalty will go up to $ 210.)

Which entities are affected by this change? Individuals (all forms 1040, including non-citizens). Estates and Trusts (Form 1041). Corporate Files (all forms of the 1120 filing). And, Non-Profit entities that can file a 990-T (they have unrelated business income of $ 1000 or more.)

There are more penalties, too. These were included in the Trade Package Legislation. The act included late filing of 1099 forms, W-2s, and 1095 (Health Care Reporting). You will note that the deadlines for some of these forms have been moved up- so pay attention and file them on time. Because the penalties can be $ 1060 for each delinquent 1099 form- because you have intentionally filed late to the government AND to the payee!

Of course, if you file the 1099 only 30 days late, the penalty is $ 50 (again- for each – the payee and the government). If you get your act together by 1 August, the penalty is $ 100 (again, for each). And, if you miss that date, the penalty is $ 250 each- unless the IRS feels it was intentional (and you know that number is $ 530).

There you have the big changes for the year. Now, you should be ready to file your taxes comes the 1rst of the year. But, don’t expect really fast refunds (as one would have expected before). Because the IRS is going to be checking to make sure the taxpayer is legit- they don’t want all those identity theft and tax fraud situations to obtain.

Increasing Tax Planning: A Case of a Wolf in a Sheep Skin?

The effects of tax avoidance and tax planning on the society has been a controversial issue for a long time yet governments the world over still have difficulty addressing it. It is believed that all these started from the beginning when business agreements were written by the government or associates of government to favour their family, friends or associates that are in business. Unfortunately, tax planning schemes are a legally accepted business practices for which tax professionals are paid huge sums of money to offer tax planning advisory services for both personal and corporate decision making.

According to Investopedia, tax planning is the analysis of a financial situation or plan from a tax perspective. It is an exercise undertaken to minimize tax liability through the best use of all available resources, deductions, exclusions, exemptions, etc. to reduce income and/or capital gains (businessdirectory.com). Tax planning therefore encompasses many different considerations, including the timing of income, purchases and other expenditures, the selection of investments and type of retirement plans etc. However, tax fraud or evasion unlike tax avoidance is not tax planning scheme and hence considered illegal in the tax professional.

Firms, both domestic and international employ numerous tax planning strategies to reduce their tax burden. An exhaustive review is impossible because known strategies are numerous and many strategies are likely unknown to tax analysts. Some forms of tax planning include (a) reclassifying business income as non-business income (b) using transfer pricing to shift income from high tax to low tax jurisdictions (c) employing passive investment companies (d) exploiting tax credits, exemptions and/or concessions in Tax Laws (e) treaty shopping (f) use of hybrids etc.

Judge Learned Hand in the case of Commissioner v Newman in 1947 stated:

“Over and over again courts have said that there is nothing sinister in so arranging one’s affairs so as to keep taxes as low as possible. Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is mere can’t”.

Indeed, tax planning has invariably become an integral part of a financial plan, as reducing tax liability and maximizing eligibility to contribute to retirement plans are both crucial for business success as it has gained prominence in today’s business planning strategies, all because Tax Laws have different provisions relating to entities based on location, type of activity or time period, thus invariably, every difference offers a planning opportunity to a taxpayer.

Then the question that arises is, does tax planning comes with any benefits?

Proper tax planning is essential in both domestic and international business to reduce the distortions that arises for instance due to the lack of harmonization in domestic tax systems. Without tax planning, entities are likely to suffer from excess tax payments and additional tax compliance costs. Among the reasons argued for tax planning are:

(a) Offers the opportunity to lower the amount of taxable income i.e. where a taxpayer’s financial and tax planning strategies are targeted at structuring expenditures to fit into the category of allowable expenses.

(b) Serves as a catalyst to reduce the tax rate at which you are taxed i.e. siting business operations at locations or business to take advantage of the little or no tax rate prevailing in that jurisdictions e.g. tax havens.

(c) It ensures you get all the credits available to you i.e. taking advantage of the tax credits, exemptions and/or concessions available in a tax jurisdiction e.g. the stability agreement provision for a holder of a mining lease in Ghana.

(d) It allows a cashflow forecast to be more effective while minimizing tax liability. A company looking to embark on massive capital or productive investment or re-investment will plan financial transactions with taxes in mind so to avoid making impulsive maneuvers. With a resultant good cashflow, entities positioned to embark on more capital and productive investments. Effective tax and financial planning maximize shareholders’ wealth, and improves cashflow for capital and productive re-investment among others.

(e) For the government, the granting of tax reliefs, exemptions and/or concessions is targeted at increasing private sector productivity, create employment and attract investors and improve cross-border trading.

Considering these benefits, won’t you recommend for more tax planning practices? Just consider these.

Governments efforts to improve national economy has always been limited due to inadequate tax revenue, which forms a larger percentage of government revenue. This could be attributed to the several tax planning schemes as well as tax evasions. In 2005, the average tax revenue to GDP ratio in the developed countries was approximately 35%. In the developing countries, it was equal to 15% and in the poorest of these countries, the group of low income countries tax revenue was just 12% of GDP and tax planning via tax avoidance are widely believed to be important factors limiting revenue mobilization.

The ActionAid and Tax Justice Network-Africa (TJN-A) in its West African Giveaway report published in August 2005 indicated that West African countries are losing an estimated US$9.6 billion of revenue each year by granting tax incentives to foreign companies and that three countries – Ghana, Nigeria and Senegal – are losing an estimated $5.8 billion a year through the granting of corporate tax incentives with Ghana’s portion being around $2.27.

Tax planning approaches like tax avoidance affect the extent to which the government can provide basic need of the population i.e. it results in inadequate supply of basic amenities such as poor infrastructure, poor educational and health systems, inadequate water and power supply as well as poor road networks. This could be one of the reasons why deficit budget financing has become the order of the day in most developing countries.

Income inequality is another adverse effect resulting from increasing tax planning. Taxation has an objective to redistribute income but the accumulation of wealth through tax avoidance schemes for instance has further widened the gap between the low-income earners and the high-income earners.

During an international conference jointly organised by OXFAM International and the International Tax Justice Network, Africa in Accra in February 2014 for instance, the Deputy Campaign Manager of OXFAM, Mr. Stephen Hale, indicated among other things that many developing countries faced challenges in their efforts at mobilizing domestic resources due to factors such as regressive tax regimes, wide range of corporate tax incentives etc.

But the question remains that, if the major source of revenue to every government is tax revenue whiles government revenue and capital expenditures are highly dependent on these tax revenue, can we then conclude that Governments efforts to reduce budget deficits and over reliance on development partners to finance national budget is a dead on arrival discussion, as most of the tax revenue loss is attributable to tax planning schemes such as tax avoidance, tax incentives and poor tax education and awareness?

Probably tax planning is not that beneficial to government as we are made to believe but instead a wolf in a sheep skin which is gradually ripping off government of billions of dollars in tax revenue to meet its huge public expenditures and to make reasonable economic policy. But who is to be blamed, the taxpayer, the government or both? I leave you to judge!

Tax planning has indeed come to stay, however, I suggest that (a) accountability on the part of governments and effective use of tax revenue will instill faith in the government thereby encouraging payment of taxes, (b) anti-avoidance provision should be of general application or refer to specific tax havens or tax avoidance devices (c) the concept of ethical and responsible investing should not be limited to companies products/services but also to their impact on society as well as (d) unification of tax rates and (e)The Organisation for Economic Co-operation and Development (OECD) and the United Nations which are famous in their models for international taxation should consider paying more attention to the increasing domestic and international tax planning schemes.

Desmond is a Consultant at Danisa Consult (Accounting, Audit & Tax) and a Facilitator for accounting, tax and audit at Global Institute of Resource Development (GiRD), a Capacity Development and Training Institution. A member of the Institute of Chartered Accountant, Ghana; Chartered Institute of Taxation, Ghana; Association of International Accountants, UK; International Association of Accounting Professionals, UK; Association of Certified Fraud Examiners, US; Southern African Institute of Business Accountants, SA.

Tax Reforms

Implementing “flat tax” on Income Rate
One tax reform issue that requires addressing is the amount of revenue that needs to be raised by the federal tax system. When there is a disproportion between revenue and spending, debts and federal deficits will increase and reach unsustainable limits. Policy makers need to assess tax policies and come up with ways of alleviating fiscal pressures. Implement a flat tax on income at a rate of 18% for all Americans. Having a flat tax for all Americans will ensure that all citizens are taxed equally and there is no bias. However, a rate of 18% is too high for the citizens taking into account the citizens have different incomes. Implementing this policy will not be beneficial to the government, as it would benefit high-income earners only.

The working class in America pays too much in taxes compared to cooperation’s and millionaires. Most big and profitable corporations pay little on taxes as compared to the middle class citizens. If corporations and the rich pay their fair share, the nation will afford to cut taxes for most of its middle and common citizens. This can also be boosted by cutting on wasteful spending on weapons, military and war. On the contrary, taxing more on high-income earners will result to the government having more money to waste. It also acts as a deterrent for business and individuals to make money. This might lead to a reduction in investment by investors. In the past, high taxation slowed down the economy and resulted in stagnation. Cutting taxes on businesses promoted the revenue. However, increasing taxes led to a reduction in business spending and investments as they tried to cut their tax expenditure resulting to a decrease in revenue for the government.

Implementing Democratic Party’s Reform
There is an unbalanced proportion of Individual wealth in the US. Aggressive steps needs to be taken for a restoration of fair income distribution. The middle class and the poor pay a lot in terms of federal tax which is due to the unfairness of state taxes. System wide tax reform should be implemented to simplify the tax system. A tax policy should be implemented to eliminate loopholes. Democrats hold the idea that taxes should be increased for the upper class and reduced for the middle class. The tax code and system needs an overhaul. The United States needs a code that creates wealth for people and rewards work and not a code, which generates wealth for those who have it. 200000 dollars should be set at the income level where Americans should be taxed more heavily. This will pave way for cutting taxes for the rest of the citizens. Increasing taxes for wealthy Americans will lead to a 98% cut in taxes where most families will be able to meet their daily economic challenges.

GPO Blueprint Tax Reform Proposal
A proposal by the house GOP blueprint proposed that the corporate income tax should be replaced with a Destination Based Cash Flow Tax (DBCFT). This would help the cooperate income tax and the US worldwide tax system eliminate the distortions it caused. The worldwide system will be replaced with a territorial tax system where companies will be taxed based on their locations of profits and not according to their corporate residence. Companies in the US that earn profits overseas would not be taxed again on their profits when they are brought back to the United States. This tax system would also allow a free flow of capital back to the US by eliminating the lock out effect. This would encourage companies to expand and invest operations throughout the world.

Changing Tax Rates
The plan is to cut taxes at all income levels, but the taxpayers earning high incomes will receive the biggest cuts. The average tax bill will then be cut by 1810 dollars, which would increase the income by 2.5% after tax. The top 1% taxpayers would then benefit by 3/4 of the tax cuts while highest taxpayers would see a decrease in 16.9% tax cut after tax income. The middle class households will receive an estimated 0.5% tax cut after tax income while the poorest American would see a downfall in their tax cut 0.4% after tax income. The plan would see a reduction of 33% by the top individual tax income rate, 20% by the corporate, and 25% for partnership and sole proprietorship. This would reduce the child tax credit and standard deductions.

A cash flow consumption tax would replace the corporate income tax, which would apply for all businesses whereby interests in business would not be deductible and investments would be immediately deducted. This would result in a border adjustable cash flow tax with exclusion of exports receipts and imports purchased would not be deducted. This marginal tax rate cuts would reduce tax rates on new investments, incentives on US investments would be increased, and tax distortions would be reduced on allocation of capital. However, interest rates would increase in the event of increasing government borrowing and lead to a crowd out on private investment. This would offset the positive effects of the plans on private investment. In order to counteract the ramification of the tax cuts on the deficit the federal spending needs to be reduced.

VAT Implementation
National consumption tax (VAT). This is a levy on the difference between the purchase of goods and its sales. Generally, the tax is calculated on a business according to its sales, a credit for taxes that is paid on its purchase is subtracted and the difference is forwarded to the government. The incomes of multinational corporations that are resident in the United States should also be taxed. Discretionary and mandatory spending should also be reduced which will lead to a reduction in deficits and debts. Lowering federal spending on healthcare and reducing revenues below baseline amounts would offset deficit reduction. This would lead to an increase in domestic investment, national saving and the capital stock would be increased.

Dealing With Tax Professionals To Achieve Improved Compliance With The Laws

The majority of taxpayers in EU countries use tax professionals in some shape or form, and for this obvious reason the EU tax administration recognises that they play a very important role in their tax system. As well as helping to make the system run smoothly, they play a key role in influencing and shaping the tax compliance behaviour of their clients. This influence may be positive or negative, because of their professional knowledge of our tax system and its nuances.
Through their representative bodies, tax professionals also have an important role in developing our tax system. They are influential in forming public opinion and general attitudes as to the fairness and equity of the tax system and our administration thereof.
Because of their influential role and the unique position they have in influencing taxpayer behaviour, we recognise that they are one of the primary ingredients in our pursuit of our main corporate goal: “To ensure that everyone complies with their tax and customs responsibilities”.
We therefore spend a lot of time engaging with them using a combination of methods and through many different forums in our efforts to achieve improved taxpayer compliance.

WHAT CAN BE TAX STRATEGY ?

Our strategy in relation to dealing with tax professionals can be laid out in our recent Operational Strategic Programme 2007-2010. Because of the fact that the phrase “tax professional” encompasses persons with a variety of roles and responsibilities, the tax administration must prepare a response to ensure that strategy works.
I would like to give you some background on how the building relationships and partnerships strategy will come about. The relationship between taxpayers and tax administration, I must confirm that is very much an adversarial one characterised by mutual distrust and suspicion. Tax administration recognises that albanian tax professionals have a key role and that is why we have developed sophisticated consultative mechanisms to help administration engage with this wide community.
Let me give you some relevant facts about the Albanian tax system.

ALBANIA’s TAX SYSTEM

Our tax system is concerned with direct and indirect taxes, customs and duties. Albania has taxes on incomes, as well as taxes on goods and services.
Businesses (limited companies and individuals) pay tax on a self-assessment basis. There are approximately 49,000 self employed individuals and 13,000 limited companies on our register.
The General Taxation Directorate is the sole central tax authority in the Republic of Albania. The General Directorate of Taxes (HQ) and its Branch Offices in the districts possess authority to implement and administer taxes. The General Directorate of Taxes is located in Tirana. The General Taxation Directorate establishes its Local Tax Offices in 36 districts and since 1998 is established in Tirana the Large Taxpayer Office. Local Tax Office Heads are appointed and discharged by the General Director of Taxes. The Local Tax Offices provide taxpayers with tax certificates, prepare draft program of tax revenues for the district, supervise and are accountable for accomplishment of the tax revenues and the program, process tax declarations, assess tax liabilities, preserve and organise documents, audit taxpayers and collect taxes as well as implement special executive decisions.
General Taxation Directorate has recently undergone a major organisational restructuring. Essentially, this agency has rebuilt the organisation around different groups of taxpayers. These groups consist of taxpayers in each of four geographic regions and a national large taxpayer group. Apart from collection and debt management functions which remain centralised every other small taxpayer is managed from 2007 from tax offices of local power, as effect of fiscal decentralization in Albania.

WHO AND WHAT ARE ALBANIAN TAX PROFESSIONALS ?

In aLBANIA, a wide range of tax professionals such as accountants, lawyers, tax consultants, businesses and freight forwarders acting on behalf of their clients, the taxpayers, interacting with tax offices. These tax professionals perform a wide variety of functions.
The variety of professionals providing a great deal of tax advice or engaging in compliance activities is generated on the activities of such professionals. For example, accountants, advising on business transactions and internal audit; lawyers such as solicitors and barristers advising on business transactions, conveyancing, estate administration and litigation; auctioneers and real estate agents advising on capital transactions, and customs agents advising on customs matters. Each of these activities in its own right involves some form of tax advice and each professional can be regarded as a “tax professional”, each of which, play a very important part in ensuring that our tax administration and systems work.
Traditionally most VAT businesses and a little number of self-employed persons, i.e., businesses, professions, companies and their directors, use the accountant as tax professional, or “agent”, to engage with tax officials. This high level of representation, even for small business, is because we don’t operate an imputed income system. All businesses have to prepare business accounts on an “accruals” basis, and this generally requires the services of an accountant.
In Ireland we refer to our mainstream tax professionals as “tax practitioners” or “agents” and there are approximately 2,000 such “agents” registered in tax offices when they act as tax return preparers. As a result of this high level of agent representation, taxpayers in Albania tend not to be inhibited about challenging tax administration, and engage in more sophisticated business transactions and use tax professionals to this end.
Another reason for taxpayer challenges is the recent phenomenon of taxation departments being created in legal firms. Also, many corporations are employing lawyers who specialise in mainstream taxation matters and now lawyers are not just engaged in the traditional legal bastions of capital taxation and inheritance tax matters. Primarily, as a result of our Tax Investigation Department a dedicated part of tax administration which pursues the proceeds of crime, our barrister profession, who traditionally did not advocate in taxation matters, are now representing more and more taxpayers in tax matters in the civil and criminal courts.
This increasing competition from the legal profession has raised some issues as regards a level playing field between the different professions. Accountants see the prospect that lawyers might be able to claim legal professional privilege on behalf of clients against Revenue enquiries in certain circumstances as an unfair competitive advantage.

INFLUENCING COMPLIANCE BEHAVIOUR

One of the obvious benefits for tax administration from the engagements with tax professionals is the extent to which they can get them to influence good compliance behaviour. As already mentioned, tax offices regard tax professionals as being hugely influential in terms of promoting good compliance behaviour; indeed, because they may be the only point of contact that a taxpayer has in his/her interactions with tax administration.
However, it is important that tax professionals also see it as in their interest to do so. Not alone does ‘non-compliance’ cost money in lost taxes for tax administration, but it also puts the taxpayer, the client, at serious risk of severe consequences if caught. Being able to deal with taxpayers through their agents substantially reduces the cost of tax administration. Think of what life would be like for a tax administration if there were no tax professionals. Some people who work for tax administrations might say that life would be much easier without them. Yes, there might not be so much tax planning, or challenges to taxation, and taxpayers might be more willing to accept tax administration’s view. This might make life easier for the tax officials. But given the complexity of tax system for enyone that it’s no part of tax administration, despite all the efforts at simplification, think of what the disadvantages might be?
Instead of funnelling the interaction with businesses and corporations through 2,000 tax professionals, it would be necessary to interact directly with an additional 49,000 business and over 13,000 corporate taxpayers. This would have huge cost implications for tax administration, as more employees would be needed to service the substantial additional contacts and queries that would ensue.
It would also be immeasurably harder for tax administration to ensure that all taxpayers understood their obligations and this would adversely affect voluntary compliance.
For these reasons, tax structures try to make it as easy as possible for tax professionals to meet their client’s compliance obligations and we provide a variety of support services and measures to support and achieving client’s compliance.

SUPPORT AND SERVICE FOR TAX PROFESSIONALS

Tax professionals have a big interest in customer service efforts and are rightly critical when the tax services falls below standard. After all, the tax professional is in business to make a profit. Poor service on the tax offices costs money and the taxpayer does not always understand either.
Here are some examples of how tax administration can support and try to try to make life as easy as possible for tax professionals.

Simpler Organisational Structure
In the albanian tax structure, all taxes pertaining to a taxpayer are handled by one office. Prior to that, a taxpayer (or tax professional) could have to deal with a number of offices depending on the tax.
This tax structure makes it much easier for the tax professional to deal with their client’s compliance obligations. However there are problems following the reallocation of all our taxpayer cases in the restructuring period. For some time, tax professionals are unsure which office dealt with their clients. As a result of good contacts with the various professional bodies and in a spirit of openness and co-operation, which is part of taxation strategy of building partnerships, is the possibility for tax officials to engage proactively and positively with a view to implementing practical measures to remedy difficulties.

Some of these initiatives help illustrate this:

o Contact Points
There are special contact points in each of the regions for tax professionals who are experiencing service difficulties in dealing with tax administration. These contact persons are empowered to sort out the difficulty.

o Contact Locator
There is a tool known as ‘Contact Locator’ ,that in albania is not a function used, but in EU countries he can be used to find out which office deals with a taxpayer.

Information Tools
Tax strategy is to ensure clear and timely communication. Some of the many information tools are ready for providing up to date informatio:

– Tax Buletin

– Tax leaflets

– Seminars and workshops

o Technology
By exploiting technology opportunities as much as possible such as electronic e-filing service, tax structures are able to provide better service while at the same time reducing compliance and their administrative costs. This makes it easier and cheaper for tax professionals to file and pay.

o Fair procedure
Through mechanisms such as tax procedures and Tax Audit Practice Guidelines and other papers and circulars that help the conduct of tax strutures in confront of taxpayers and tax proffesionals.

CONSULTATION

While, everyone recognises that albanian tax administration has responsibility for the tax system and makes the final decisions, we know that we can do things more effectively, if there is a spirit of cooperation and mutual understanding with tax professionals.
Both tax structures and tax professionals have a mutual self-interest in bringing common sense and clarity to what is a complex area of business and personal life of taxpayers. The consultation is very important – our strategy is that we listen, we exchange views and ideas, and we generate ideas. On the other hand it is important to get the professional’s practical business perspectives and learn from their experiences. Sometimes a more informative practical viewpoint, e.g. learning practical insights and difficulties in operating legislation, is a more valuable insight than discussions about proposals or the difficulties in implementation of current legislation in an internal vacuum.

BENEFITS TO TAX ADMINISTRATION

As well as the invaluable role, played by practitioners in promoting and fostering a pro-compliance culture in Albania, they have also been a significant catalyst and facilitator of some of the major changes in tax administration here.
Tax administration has make changes to keep pace with one of the fastest growing economies in the mediterranean region over the last 5 years which has brought enormous challenges for us on many fronts, but particularly in terms of:

– Growing number of taxpayers
– Taxpayers with increasingly complex and financial and investment profiles

All of the changes have occurred while resources have remained static. With the support (and sometimes the forbearance) of tax professionals, tax administration has managed to transform itself from an organisation that was focused on process and procedure, structurally frozen, averse to change and largely indifferent to its customers’ needs to one which is trying now to customer focused, more effective in its core businesses, structurally flexible, risk driven and looking forward with enthusiasm to the challenges ahead.
I would like to illustrate this by mentioning just a few of these major changes and the role of tax professionals in facilitating them:
The near future tax declaration-on-line filing service in Albania, it’s aspected to be a phenomenal success. In industrialised countries of EU, even though e-filing is not mandatory, over 53% of self employed taxpayers filed on-line last year, in order to be increased to over 60%. This is because so many of the returns are filed by tax professionals who have been active partners in our e-filing success. As a result, there have been huge benefits for both Revenue and practitioners in terms of service and cost. Tax professionals have been the most enthusiastic supporters of our on-line filing system and we are continuing to work closely with them in developing it to ensure that it continues to meet their needs and concerns re service, security and confidentiality.

CHALLENGES AHEAD

There are some serious challenges ahead for the Tax Administration -Tax Professional relationship. Some of the main ones are that come to mind are:

Tax Planning and Avoidance
It would be wrong to give the impression that tax structures accept everything that the tax professional engages in. One of the main areas of contention is ‘avoidance’ or aggressive tax planning. While professionals have a key role to play in relation to promoting compliance, there are problems sometimes when tax planning steps over the line. Of course tax offices understands the motive for tax planning. Naturally, all taxpayers want to pay less tax and if there are ways of avoiding tax, and some are willing to pay a lot of money for it. The problem is when such schemes have the potential to undermine the integrity and legitimacy of the tax system in the wider community.
There is an ongoing debate with tax professionals as to where that line is – what’s acceptable and what’s unacceptable. The tax administration’s objective is to move tax professionals and their clients away from getting involved in unacceptable tax planning schemes. On the other hand, albanian tax administration are closely monitoring new developments in other countries to establish the best approach to take to change behaviour in this regard.

Integrated Revenue view of Taxpayer and Risk
The tax administration approach to tackling risk, in tax structures, is to analyse risks for a taxpayer across all taxes. This makes it more difficult for the general tax professional who may act in relation to some of the taxes only. It may present particular problems when preparing for a revenue audit when the full range of taxes and duties, from income tax to excise duties, could be reviewed.

More Professional Regulation
It’s not just tax administration that tax professionals have to deal with. They have to contend with more and more statutory reporting requirements from other bodies such as the Prosecutor, money laundering department, Customs, and many other public agencies regarding company law offences, to illustrate just a few regulatory bodies. The whole compliance environment is becoming more difficult for the practitioner and this is not being made easier by duplication of requirements from the various public bodies. However, we are working with other agencies to try and streamline matters where possible.

Finishing off Legacy Business
In the last four years, tax investigation units have carried out a number of large investigation projects aimed at dealing with tax evaded on funds hidden by way of various means, such as money laundering in the registered businesses, under reporting or missing declarations of incomes etc .
As mentioned earlier, there is a new investigation scheme underway into undeclared funds hidden. Because of the numbers of taxpayers involved, approximately 1, 000 over the last 2 years, tax professionals are complaining about the strain that all this extra work is placing on them which is in addition to their normal advisory and returns preparation work. The timing and management of some of these special investigations has been a bone of contention with them and this has caused some difficulties in their relationship with tax administration.

CONCLUSION

Tax professionals sometimes ask hard questions which tax officials may not have asked themselves and, which tax administration has to answer. This ultimately is of benefit to tax administration as it focuses them on dealing with and addressing difficult issues, which may have been overlooked.
As key stakeholders they want tax professionals to have a sense of ownership in the tax system. This partnership approach with them also helps to counter relationships of distrust and enables tax administration to create real relationships. To this end, the good relationship with tax professionals can help in building public confidence in the tax administration. In terms of our objectives, we have benefited from our approach with them. However, tax officials should not get carried away. While they have a long engagement, the marriage has been more one of convenience than of love for each other. Paying tax will never be popular and there will no doubt be serious difficulties ahead. This relationship overall is on a sound footing and capable of withstanding whatever troubles lie ahead. In this conclusion I can pronounce the sentence that I’m carrying in my mind always “Tax administration need tax professionals and they need tax administration”.

Victory Tax

One of my favorite movies is The Matrix. The reason why I like it so much is because it is actually based on truth (like a lot of fiction movies are). While doing research on the things of this world, I have come to realize that a lot of things that we have been told, and things that we believe to be true, are not.

For example, most Americans believe the following statements:

Microwaved food is safe for human consumption.

There is a law requiring citizens to have a social security number.

Fluoride is good for your teeth.

Michael Moore exposed the REAL truth behind 9/11.

The cost of living goes up every year.

Vaccines are effective, necessary and safe!

High cholesterol causes strokes and heart disease.

The house you live in is a good investment.

The Federal Reserve Bank is federal and has reserves.

There are no known cures for HIV/Aids.

Now, all of the above statements are “known” facts. But if you would do your own research…. Wait, let me state that again. IF YOU WERE TO DO YOUR OWN RESEARCH, you would find that not only are the above statements false, but in most cases, they are the complete opposite of the truth.

Now, I don’t have time to go through all this, so right now I will focus on the tax controversy.

There are two basic types of tax. There is indirect tax and direct tax. The term indirect is in reference to a person’s labor. For example, gas tax, tobacco tax or sales taxes are all indirect taxes. Social security, Medicare and Federal income taxes are direct taxes on your labor. Generally speaking indirect taxes are avoidable, whereas direct taxes are not.

Now, the Constitution states in Article 1, section 9, “No capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken.” To make this real simple and plain, “No direct tax on labor is allowed unless it is split up evenly among everybody”

By the way, if you are a federal employee, you are considered by the government to be privileged as opposed to a private sector worker. Since your income is derived from gains (tax of citizens), it is constitutional to lay tax on your wages. That is “considered” an indirect tax.

Here is how the Supreme Court describes it;

“An income tax is neither a property tax nor a tax on occupations of common right, but is an excise tax.” “The legislature may declare as ‘privilege’ and tax as such for state revenue, those pursuits not matters of common right, but it has no power to declare as a ‘privilege’ and tax for revenue purposes, occupations that are of common right” Simms v. Ahrens, 271 SW 720 (1925)

Congress on the other hand has the right to tax gains or profits. Examples would be dividends, royalties, alimony, pensions and things of that nature.

So doesn’t this mean that the Federal Income tax that we pay nowadays is unconstitutional? No it doesn’t!!! Let’s start at the beginning.

The Beginning of Income Tax

In 1862, America was in the midst of a civil war. Abe Lincoln thought that this would be a quick and painless war, but it turned out to be long and bloody. President Lincoln had left the gold standard and started printing money (greenbacks) out of thin air to finance northern government. This caused inflation in the dollar supply. So on July 1st 1862, they passed the Internal Revenue Act of 1862 (which was a revision of an earlier flat rate income tax passed in 1861) to combat inflation and finance the war.

This was the first income tax and it was put on the pay of government workers and it was withheld. Luxury taxes (remember the monopoly board?) were imposed on a long list of commodities, including alcohol, tobacco, jewelry, yachts, playing cards etc. The act taxed licenses (on almost all professions) and also gains and profits (receipts from corporations, interest and dividends) as well as stamp tax and inheritance tax.

This Act established that income is ‘gains’ or ‘profits’. This is the reason why only government workers paid it. If income meant anybody’s wages that had a job, then obviously everyone would have been taxed, and of course, that would have been unconstitutional. A person’s labor is his own personal property and cannot be taxed.

“It has been well said that ‘the property which every man has in his own labor, as it is the original foundation of all other property, so it is the most sacred and inviolable. The patrimony of the poor man lies in the strength and dexterity of his own hands, and to hinder his employing this strength and dexterity in what manner he thinks proper, without injury to his neighbor, is a plain violation of this most sacred property’.” Butcher’s Union Co. v. Crescent City Co., 111 U.S. 746 (1883)

The Sixteenth Amendment

In 1894 Congress enacted another federal income tax. This tax would allow for not only salaries but ANY OTHER compensation that was paid to anyone who was in the privileged sector. The Supreme Court declared that this was unconstitutional because if you tax gains from personal property, then that is just like taxing the property itself, and is therefore a direct tax.

“The power to tax real and personal property and the income from both, there being an apportionment, is conceded: that such tax is a direct tax in the meaning of the Constitution has not been, and, in our judgment, cannot be successfully denied:…” Pollock v. Farmers Loan & Trust, 157 U.S. 429 and 158 U.S. 601 (1895)

But this created a loophole. Someone who had otherwise “taxable income” could attempt to get out of paying taxes by assigning that income to his/her personal property which would take it out of the category of indirect and make it a direct tax. To make a long story short, this is what led to the 16th amendment.

The 16th amendment reads “The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States….”

So, did this amendment authorize everyone to be taxed, or did it just close the loophole? If you notice, it doesn’t say that congress has the power to lay and collect direct taxes. So in order for this amendment to be compliant with Article 1, section 9 of the constitution, it would seem that it could only mean the same indirect tax that it had always meant. What did the Supreme Court have to say about it?

“The 16th Amendment does not extend the power of taxation to new or excepted subjects, but merely removes the occasion for apportioning taxes on income among the states. Neither can the tax be sustained as a tax on the person, measured by income. Such a tax would be by nature a capitation rather than an excise.” PECK v. LOWE, 247 U.S. 165(1918).

“The 16th Amendment conferred no new power of taxation, but simply prohibited the previous complete and plenary power of income taxation possessed by Congress from the beginning from being taken out of the category of indirect taxation to which it inherently belonged.” STANTON v. BALTIC MINING CO., 240 U.S. 103 (1916).

“The 16th Amendment must be construed in connection with the taxing clauses of the original Constitution and the effect attributed to them before the amendment was adopted.” EISNER v. MACOMBER, 252 U.S. 189 (1920).

So, it looks like the fact that it is said that international bankers (J.P. Morgan, Paul Warburg, and John D. Rockefeller) bribed Secretary of State Philander Knox into fraudulently declaring that the 16th amendment had been properly ratified when it had not, really didn’t matter. Even after the 16th amendment, only a small percentage of Americans paid “income” tax.

So why are we ALL paying it today?

Ah yes, the plot thickens. During WWII (by now you probably realize that wars are just GREAT for the economy…. Who’s economy?), the government wanted to raise money for the war so they enacted the Victory Tax of 1942. This was to be a temporary two year tax supposedly authorized by Article 1 Section 8 clause 12 of the constitution which says that Congress has the power: “To raise and support armies, but no appropriation of money to that use shall be for a longer Term than two years”

This was a direct tax on everyone’s labor and would have been unconstitutional if it was enforced, so it had to be voluntary (even though they didn’t tell the public about the voluntary part). Now the IRS says the 16th amendment authorizes them to tax everyone’s labor. But since the sixteenth amendment was already signed, it would appear that this Victory Tax would have been unnecessary. Maybe the government didn’t realize this at that time. There had to be a way that they could get everyone to pay this voluntary tax so the wicked ones unleashed one of their greatest weapons (Hollywood) to do what it was made to do, program the minds of the people!

Henry Morgenthau, the Secretary of the Treasury at the time, ordered John J. Sullivan, a Treasury Department official, to contact none other than Walt Disney! Walt flew in to D.C. to have a meeting with Morgenthau and Internal Revenue Commissioner Guy Helvering. Morgenthau told Walt that the U.S. wanted him to help sell people on paying the income tax. Walt wondered why this was even needed. Couldn’t you just throw people in jail if there was a law saying you must pay? Mr. Helvering told Walt that he wanted people to be enthusiastic about paying taxes.

So Walt went back to California and put a short movie together called “The New Spirit”. The objective was to make people feel it was their “patriotic” duty to pay the income tax. It starred Donald Duck (Walt’s biggest star at the time). Along with this movie, “Inflation” and “Spirit of 43” all played instrumental roles in the tax propaganda.

The New Spirit

Donald wants to help the war effort but becomes reluctant when the radio announcer tells him to pay taxes, but the announcer shows him that the U.S. needs his money, and helps him through the simple tax forms. By the end of the movie, Donald is so energized that he rushes to Washington to pay his taxes in person! Donald learned to pay his “Taxes to beat the Axis”

Inflation

The Devil receives a telephone call from Adolph Hitler, who asks for the Devil’s help in the war effort. The Devil tells Hitler that he will cause high inflation in the USA, and his worries will be over. He encourages the audience to buy as much as they can so that goods will become scarce and prices will go up. Hoarding rationed goods and cashing in war bonds will also help. Factory worker Joe Smith just got a raise in pay, so he starts buying everything on the installment plan, including a fur coat for his wife. After the Smiths hear a radio address by President Roosevelt, they realize that they should be more prudent in their spending habits to help the war effort. Written by David Glagovsky

Spirit of 43

Donald cashes his paycheck and is unsure how to best spend his money. Two aspects of his personality materialize: ‘Thrift’ and ‘Spendthrift’. Thrift tells Donald he should save to pay his taxes, but spendthrift tells Donald that it is his money and he should spend it how he pleases. In the end, Donald realizes that it is his duty to serve his country and pay taxes.

According to tax historian John Witte, “In 1939, about 15% of the people paid income tax. That’s all, period. At the end of the war, we had 80% of our families paying income tax.” Just entertainment huh?

In 1944, the Victory Tax was repealed by section 6 of the Income Tax Act of 1944 after it had been renewed. But, for some strange and unknown reason, Congress decided to keep it on the down low. Because most people didn’t know about it, they just kept paying taxes.

So I guess we are all here today, still paying the Victory Tax voluntarily. Tell me, do you feel victorious?

Trickeration of the IRS?

The IRS would like you to believe that everyone must pay tax. They would like you to believe that the 16th amendment gives them that right and that the law is the IRS code. But according to the Supreme Court, the code is not the law, it is just the regulation and assessment of the law. The law is the Constitution.

The revenue laws are a code or system in regulation of tax assessment and collection. They relate to taxpayers, and not to nontaxpayers. The latter are without scope” United States Court of Claims, Economy Plumbing and Heating v. United States, 470 F.2d 585, at 589 (1972)

The IRS threatens the public and says, “All employees must be taxed. All employers must make their employees fill out a W-4, and administer a W-2. All income must be taxed”. But, according to Pete Eric Hendrickson, author of “Cracking the Code”:

“That “income”, “wages”, “self-employment income”, “employee”, “employer” and “trade or business”-as these and certain other terms are used within, and in regard to, the tax law-have narrow legal meanings exclusively involving, and applying to, certain privileged activities, such as holding or administering a government office, or working in one.”

Maybe this is why the 16th amendment does matter. Because the 16th amendment’s language is what enables the general public to believe they have to pay. Maybe the wicked ones knew this when it was declared ratified. It seems that this bribe would be a good investment. Without this amendment, very few of us would believe we have to pay tax today.

According to the Supreme Court, when you fill out your W-4, you are voluntarily entering into an agreement with the federal government, and claiming that the money you receive is taxable “income”. And since you sign this under penalty of perjury, you are also voluntarily waving your 5th amendment right! You just don’t realize it.

“A tax on income is not economically or legally a tax on its source.” However, wages, salaries, commissions, and tips (sources) are considered to be “income” for an individual when he lists them as “income” on an IRS tax return form. When he signs the tax form under penalty of perjury, he has made a voluntary oath that his wages, salary, commissions, and tips listed on the return are “income” and that he is subject to the tax.” Graves v. People of the State of New York ex rel O’Keefe, 59 S.Ct. 595 (1939)

So when the IRS, comes and knocks your door down, seizes your property and throws you in jail, don’t say that it is unconstitutional. The Supreme Court says it’s not unconstitutional, for you told them that you worked for the government and that you made “income”. Since the lower courts are not in compliance with the Supreme Court, the judges don’t care about Supreme Court rulings, and since the government has already stated that they don’t have to show a law that requires citizens to pay tax, your complaints could very well go unanswered.

Is this the dirty little secret that the IRS doesn’t want you to know? Is this why the IRS chooses to audit certain people when they know millions don’t pay and they could just go after them?

I am not an accountant or a lawyer! This article is not intended to incite you to take any action. THIS ARTICLE IS FOR INFORMATIONAL PURPOSES ONLY! Do your own research, and make an informed decision.