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.

Tips to a Successful Tax Return

Having the right team of advisors is critical to achieving your financial goals faster than you ever thought possible. For most people, taxes are the single biggest expense. This makes finding the right tax preparer for your team extremely important.

HOW DO YOU FIND A TAX PREPARER THAT IS RIGHT FOR YOU?

First, not all tax preparers are the same. I previously wrote an article about this last year titled: “Tax Returns – Are they really all created equal”, and you may be as surprised as other readers about just how much tax return preparation can vary.

In fact, I calculated the average savings I typically find from annual tax savings, reducing professional fees and audit assessments. In total, the average savings are:

– $23,750 Annual tax savings

– $5,000 Audit defense savings

– $10,000 Reduced audit assessment savings

– $50,000 Reduced legal fees

– $3,000 Reduced tax return preparation fees

This is a total average potential savings of $91,750! Your tax preparer does make a difference! How much more could you do with these savings?

Second, the right tax preparer for you depends on what is important to you. Take a minute to answer this question:

WHAT MAKES YOUR TAX RETURN SUCCESSFUL?

How you answer this question will impact what type of tax preparer you need on your team. I’ve asked this questions to clients, prospects and colleagues. I have compiled the most popular answers and what it means to you as you find the tax preparer for your team.

ANSWER #1: Paying the least amount of tax legally

Your tax preparer needs to:

– Know the tax law very well and know how to be creative legally.

– Ask you a lot of questions about your situation in order to understand your situation and goals.

– Have a review process where at least one other person reviews your return solely for the purpose of how to reduce your taxes legally.

HERE ARE SEVEN (7) QUESTIONS YOU SHOULD ASK YOUR TAX PREPARER TO DETERMINE IF IT’S A GOOD FIT:

Q1: Can you tell me about the other ___________ (your industry) you service?

A: Your tax preparer needs to know how the tax law applies to your situation. Having other clients in your industry or with similar investments indicates that the tax preparer is likely to be familiar with the tax laws that impact you.

Q2: Who will be working on my tax return?

A: It’s very common (and a good business practice) for tax preparers to have staff prepare your tax return. You want to make sure the other people working on your return have the same level of expertise.

Q3: What is your tax return review process?

A: Tax preparers who are focused on reducing your taxes will have this built into their review process. Usually it involves having another experienced tax preparer review the return solely for the purpose of finding ways to reduce your taxes.

Q4: What would you have done differently on my past tax return?

A: Show the tax preparer you are interviewing your prior year tax return. Creative tax preparers will be able to give you at least one idea of what you can do to reduce your taxes by looking at your tax return for just a few minutes. If it’s creativity you are after, this is a great question to ask! But don’t expect the tax preparer to give you all the details right then and there – that’s why you pay them!

Q5: How much can you save me in taxes?

A: While it’s difficult for any tax preparer to answer this in just a few minutes of looking at your past tax return, it is possible for them to know if they can save you taxes after spending 30 minutes with you.

Q6: What deadlines do you impose on clients?

A: This may seem like an odd question for minimizing your taxes but it has a direct impact. If your tax preparer allows you to provide your information a week before the tax return is due, it’s very unlikely that the tax preparer will have the time to focus on your return to truly minimize your taxes. Tax preparers that want to reduce your taxes want your tax return information early and will communicate that to you.

Q7: What recent tax law changes should I be aware of?
A: To minimize your taxes, your tax preparer needs to know the tax law inside and out, which includes the latest changes. Your tax preparer needs to be able to answer this question without hesitation.

ANSWER #2: Minimizing tax return preparation fees Your tax preparer needs to:

– Focus on the tax work and recommend someone else for the non-tax work (such as bookkeeping).

– Request tax information in a certain format.

– Require you to input your information online.

HERE ARE TWO (2) QUESTIONS YOU SHOULD ASK YOUR TAX PREPARER REGARDING MINIMIZING RETURN PREPARATION FEES TO DETERMINE IF IT’S A GOOD FIT:

Q1: What can I do to reduce my tax return preparation fees?

A: To minimize your tax return preparation fees, your tax preparer always needs to have your fees in mind. Ask your tax preparer what you can do to reduce your fees. If you don’t get at least 2 suggestions, your tax preparer probably isn’t thinking about how to keep your fees low.

Common suggestions include:

– Have someone other than the tax preparer do your bookkeeping. I am always skeptical when a tax preparer does the bookkeeping. First, they either charge an arm and leg or if they reduce their rates to accommodate you, it means they don’t spend their time entirely on tax issues, which could indicate their tax skills aren’t up to par.

– Organize your information. Don’t bring your tax preparer a shoebox! A tax preparer that is really focused on keeping your fees down will have forms, spreadsheets and other tools available for you to use to organize your tax return information.

– Enter your information online. Many tax preparers now require clients to input their information online. Accurately entered information can help reduce fees. Caution: Information that is entered inaccurately can increase your fees!

Q2: What is your fee structure?

A: Your tax preparer needs to be able to answer this question with confidence. Any wavering could indicate that the tax preparer knows the fees are too high for you but just doesn’t want to tell you. Unfortunately in these situations, you find out too late!

ANSWER #3: Reducing audit risk Your tax preparer needs to:

– Know the tax law very well and how to properly report your activity.

– Understand the IRS’s current “hot buttons” or “red flags.”

– Offer an audit defense plan.

HERE ARE FOUR (4) QUESTIONS YOU SHOULD ASK YOUR TAX PREPARER IN REGARDS TO REDUCING AUDIT RISK TO DETERMINE IF IT’S A GOOD FIT:

Q1: How many audits have you been through and what triggered the audit?

A: The most important part of this question is what triggered the audit. If it was triggered by how something was reported, then that may be something the tax preparer had control over (and may be a bad sign for you).

Q2: What was the outcome of the audits you have been through?

A: A return can be randomly selected for audit or selected because of a certain activity (even though it was reported correctly). So it’s important to understand the outcome of the audits. Was additional tax assessed or were there no changes? Additional tax may indicate that something was not reported properly.

Q3: Do you offer an audit defense plan?

A: Tax preparers that are confident in their work will offer an “insurance” program that covers their professional fees to handle your audit if your return is selected for audit.

Q4: What is your tax return review process?

A: Although tax returns can be selected randomly for audit, many are selected due to how items are reported on the tax return. Tax preparers who are focused on reducing audit risk will have a review process that includes another tax preparer reviewing your return solely for accuracy of reporting.

Tax Avoidance and Tax Evasion Explained and Exemplified

Introduction

There is a clear-cut difference between tax avoidance and tax evasion. One is legally acceptable and the other is an offense. Unfortunately however many consultants even in this country do not understand the difference between tax avoidance and tax evasion. Most of the planning aspects that have been suggested by these consultants often fall into the category of tax evasion (which is illegal) and so tends to put clients into a risky situation and also diminish the value of tax planning.

This may be one of the prime reasons where clients have lost faith in tax planning consultants as most of them have often suggested dubious systems which are clearly under the category of tax evasion.

In this chapter I provide some examples and case studies (including legal cases) of how tax evasion (often suggested by consultants purporting to be specialists in tax planning) is undertaken not only in this country but in many parts of the world. It is true that many people do not like to pay their hard-earned money to the government. However doing this in an illegal manner such as by tax evasion is not the answer. Good tax planning involves tax avoidance or the reduction of the tax incidence. If this is done properly it can save substantial amounts of money in a legally acceptable way. This chapter also highlights some practical examples and case studies (including legal) of tax avoidance.

Why Governments Need Your Taxes (Basic Economic Arguments)

Income tax the biggest source of government funds today in most countries is a comparatively recent invention, probably because the notion of annual income is itself a modern concept. Governments preferred to tax things that were easy to measure and on which it was thus easy to calculate the liability. This is why early taxes concentrated on tangible items such as land and property, physical goods, commodities and ships, as well as things such as the number of windows or fireplaces in a building. In the 20th century, particularly the second half, governments around the world took a growing share of their country’s national income in tax, mainly to pay for increasingly more expensive defense efforts and for a modern welfare state. Indirect tax on consumption, such as value-added tax, has become increasingly important as direct taxation on income and wealth has become increasingly unpopular. But big differences among countries remain. One is the overall level of tax. For example, in United States tax revenue amounts to around one-third of its GDP (gross domestic product), whereas in Sweden it is closer to half.

Others are the preferred methods of collecting it (direct versus indirect), the rates at which it is levied and the definition of the tax base to which these rates are applied. Countries have different attitudes to progressive and regressive taxation. There are also big differences in the way responsibility for taxation is divided among different levels of government. Arguably according to the discipline of economics any tax is a bad tax. But public goods and other government activities have to be paid for somehow, and economists often have strong views on which methods of taxation are more or less efficient. Most economists agree that the best tax is one that has as little impact as possible on people’s decisions about whether to undertake a productive economic activity. High rates of tax on labour may discourage people from working, and so result in lower tax revenue than there would be if the tax rate were lower, an idea captured in the Laffer curve in economics theory.

Certainly, the marginal rate of tax may have a bigger effect on incentives than the overall tax burden. Land tax is regarded as the most efficient by some economists and tax on expenditure by others, as it does all the taking after the wealth creation is done. Some economists favor a neutral tax system that does not influence the sorts of economic activities that take place. Others favor using tax, and tax breaks, to guide economic activity in ways they favor, such as to minimize pollution and to increase the attractiveness of employing people rather than capital. Some economists argue that the tax system should be characterized by both horizontal equity and vertical equity, because this is fair, and because when the tax system is fair people may find it harder to justify tax evasion or avoidance.

However, who ultimately pays (the tax incidence) may be different from who is initially charged, if that person can pass it on, say by adding the tax to the price he charges for his output. Taxes on companies, for example, are always paid in the end by humans, be they workers, customers or shareholders. You should note that taxation and its role in economics is a very wide subject and this book does not address the issues of taxation and economics but rather tax planning to improve your economic position. However if you are interested in understanding the role of taxation in economics you should consult a good book on economics which often talks about the impact of different types of taxation on the economic activities of a nation of society.

Tax Avoidance and Evasion

Tax avoidance can be summed as doing everything possible within the law to reduce your tax bill. Learned Hand, an American judge, once said that there is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible as nobody owes any public duty to pay more than the law demands. On the other hand tax evasion can be defined as paying less tax than you are legally obliged to. There may be a thin line between the two, but as Denis Healey, a former British chancellor, once put it, “The difference between tax avoidance and tax evasion is the thickness of a prison wall.” The courts recognize the fact that no taxpayer is obliged to arrange his/her affairs so as to maximize the tax the government receives. Individuals and businesses are entitled to take all lawful steps to minimize their taxes.

A taxpayer may lawfully arrange her affairs to minimize taxes by such steps as deferring income from one year to the next. It is lawful to take all available tax deductions. It is also lawful to avoid taxes by making charitable contributions. Tax evasion, on the other hand, is a crime. Tax evasion typically involves failing to report income, or improperly claiming deductions that are not authorized. Examples of tax evasion include such actions as when a contractor “forgets” to report the LKR 1, 000,000 cash he receives for building a pool, or when a business owner tries to deduct LKR 1, 000,000 of personal expenses from his business taxes, or when a person falsely claims she made charitable contributions, or significantly overestimates the value of property donated to charity.

Similarly, if an estate is worth LKR 5,000,000 and the executor files a false tax return, improperly omitting property and claiming the estate is only worth LKR 100,000, thus owing much less in taxes. Tax evasion has an impact on our tax system. It causes a significant loss of revenue to the community that could be used for funding improvements in health, education, and other government programs. Tax evasion also allows some businesses to gain an unfair advantage in a competitive market and some individuals to not meet their tax obligations. As a result, the burden of tax not paid by those who choose to evade tax falls on other law abiding taxpayers.

Examples of tax evasion are: ï?~ Failing to declare assessable income ï?~ Claiming deductions for expenses that were not incurred or are not legally deductible ï?~ Claiming input credits for goods that Value Added Tax (VAT)has not been paid on ï?~ Failing to pay the PAYE (pay as you earn a form of with holding tax)installments that have been deducted from a payment, for example tax taken out of a worker’s wages ï?~ Failing to lodge tax returns in an attempt to avoid payment. The following are some signs that a person or business may be evading tax: ï?~ Not being registered for VAT despite clearly exceeding the threshold ï?~ Not charging VAT at the correct rate ï?~ Not wanting to issue a receipt ï?~ Providing false invoices ï?~ Using a false business name, address, or taxpayers identification number (TIN) and VAT registration number ï?~ Keeping two sets of accounts, and ï?~ Not providing staff with payment summaries

Legal Aspects of Tax Avoidance and Tax Evasion Two general points can be made about tax avoidance and evasion. First, tax avoidance or evasion occurs across the tax spectrum and is not peculiar to any tax type such as import taxes, stamp duties, VAT, PAYE and income tax. Secondly, legislation that addresses avoidance or evasion must necessarily be imprecise. No prescriptive set of rules exists for determining when a particular arrangement amounts to tax avoidance or evasion. This lack of precision creates uncertainty and adds to compliance costs both to the Department of Inland Revenue and the tax payer.

Definitions of Tax Mitigation Avoidance and Evasion It is impossible to express a precise test as to whether taxpayers have avoided, evaded or merely mitigated their tax obligations. As Baragwanath J said in Miller v CIR; McDougall v CIR: What is legitimate ‘mitigation'(meaning avoidance) and what is illegitimate ‘avoidance'(meaning evasion) is in the end to be decided by the Commissioner, the Taxation Review Authority and ultimately the courts, as a matter of judgment. Please note in the above statement the words are precisely as stated in judgment. However there is a mix-up of words which have been clarified by the words in the brackets by me. Tax Mitigation (Avoidance by Planning) Taxpayers are entitled to mitigate their liability to tax and will not be vulnerable to the general anti-avoidance rules in a statute. A description of tax mitigation was given by Lord Templeman in CIR v Challenge Corporate Ltd: Income tax is mitigated by a taxpayer who reduces his income or incurs expenditure in circumstances which reduce his assessable income or entitle him to reduction in his tax liability.

Tax mitigation is, therefore, behavior which, without amounting to tax avoidance (by planning), serves to attract less liability than otherwise might have arisen. Tax Avoidance Tax evasion, as Lord Templeman has pointed out, is not mere mitigation. The term is described directly or indirectly by ï?~ Altering the incidence of any income tax ï?~ Relieving any person from liability to pay income tax ï?~ Avoiding, reducing or postponing any liability to income tax On an excessively literal interpretation, this approach could conceivably apply to mere mitigation, for example, to an individual’s decision not to work overtime, because the additional income would attract a higher rate of tax. However, a better way of approaching tax avoidance is to regard it as an arrangement that, unlike mitigation, yields results that Parliament did not intend.

In Challenge Corporation Ltd v CIR, Cooke J described the effect of the general anti-avoidance rules in these terms: [It] nullifies against the Commissioner for income tax purposes any arrangement to the extent that it has a purpose or effect of tax avoidance, unless that purpose or effect is merely incidental. Where an arrangement is void the Commissioner is given power to adjust the assessable income of any person affected by it, so as to counteract any tax advantage obtained by that person. Woodhouse J commented on the breadth of the general anti-avoidance rule in the Challenge Corporation case, noting that Parliament had taken: The deliberate decision that because the problem of definition in this elusive field cannot be met by expressly spelling out a series of detailed specifications in the statute itself, the interstices must be left for attention by the judges.

Tax Evasion Mitigation and avoidance are concepts concerned with whether or not a tax liability has arisen. With evasion, the starting point is always that a liability has arisen. The question is whether that liability has been illegitimately, even criminally been left unsatisfied. In CIR v Challenge Corporation Ltd, Lord Templeman said: Evasion occurs when the Commissioner is not informed of all the facts relevant to an assessment of tax. Innocent evasion may lead to a re-assessment. Fraudulent evasion may lead to a criminal prosecution as well as re-assessment.

The elements which can attract the criminal label to evasion were elaborated by Dickson J in Denver Chemical Manufacturing v Commissioner of Taxation (New South Wales): An intention to withhold information lest the Commissioner should consider the taxpayer liable to a greater extent than the taxpayer is prepared to concede, is conduct which if the result is to avoid tax would justify finding evasion. Not all evasion is fraudulent. It becomes fraudulent if it involves a deliberate attempt to cheat the revenue. On the other hand, evasion may exist, but may not be fraudulent, if it is the result of a genuine mistake. In order to prove the offence of evasion, the Commissioner must show intent to evade by the taxpayer. As with other offences, this intent may be inferred from the circumstances of the particular case. Tax avoidance and tax mitigation are mutually exclusive. Tax avoidance and tax evasion are not: They may both arise out of the same situation. For example, a taxpayer files a tax return based on the effectiveness of a transaction which is known to be void against the Commissioner as a tax avoidance arrangement.

A senior United Kingdom tax official recently referred to this issue: If an ‘avoidance’ scheme relies on misrepresentation, deception and concealment of the full facts, then avoidance is a misnomer; the scheme would be more accurately described as fraud, and would fall to be dealt with as such. Where fraud is involved, it cannot be re-characterized as avoidance by cloaking the behavior with artificial structures, contrived transactions and esoteric arguments as to how the tax law should be applied to the structures and transactions. Tax Avoidance in a Policy Framework We now turn from the existing legal framework in the context of income tax to a possible policy framework for considering issues relating to tax avoidance generally. The questions considered relevant to a policy analysis of tax avoidance are: What is tax avoidance? Under what conditions is tax avoidance possible? When is tax avoidance a ‘policy problem? What is a sensible policy response to tax avoidance?

What is the value of, and what are the limitations of, general anti-avoidance rules? The first two questions are discussed below What is Tax Avoidance? Finance literature may offer some guidance to what is meant by tax avoidance in its definition of ‘arbitrage’. Arbitrage is a means of profiting from a mismatch in prices. An example is finding and exploiting price differences between New Zealand and Australia in shares in the same listed company. A real value can be found in such arbitrage activity, since it spreads information about prices. Demand for the low-priced goods increases and demand for the high-priced goods decreases, ensuring that goods and resources are put to their best use. Tax arbitrage is, therefore, a form of tax planning. It is an activity directed towards the reduction of tax. It is this concept of tax arbitrage that seems to constitute generally accepted notions of what is tax avoidance. Activities such as giving money to charity or investing in tax-preferred sectors, would not fall into this definition of tax arbitrage, and thus would not be tax avoidance even if the action were motivated by tax considerations. It has been noted that financial arbitrage can have a useful economic function. The same may be true of tax arbitrage, presuming that differences in taxation are deliberate government policy furthering economic efficiency.

It is possible that tax arbitrage directs resources into activities with low tax rates, as intended by government policy. It is also likely to ensure that investors in tax-preferred areas are those who can benefit most from the tax concessions, namely, those facing the highest marginal tax rates. If government policy objectives are better achieved, tax arbitrage is in accordance with the government’s policy intent. Tax avoidance, then, can be viewed as a form of tax arbitrage that is contrary to legislative or policy intent. What Makes Tax Avoidance Possible? The basic ingredients of tax arbitrage are the notion of arbitrage, and the possibilities of profiting from differentials that the notion of arbitrage implies. This definition leads to the view that three conditions need to be present for tax avoidance to exist. A difference in the effective marginal tax rates on economic income is required. For arbitrage to exist, there must be a price differential and, in tax arbitrage, this is a tax differential. Such tax differences can arise because of a variable rate structure, such as a progressive rate scale, or rate differences applying to different taxpayers, such as tax-exempt bodies or tax loss companies.

Alternatively it can arise because the tax base is less than comprehensive, for example, because not all economic income is subject to income tax.

o An ability to exploit the difference in tax by converting high-tax activity into low-tax activity is required. If there are differences in tax rates, but no ability to move from high to low-tax, no arbitrage is possible.
o Even if these two conditions are met, this does not make tax arbitrage and avoidance possible. The tax system may mix high and low-rate taxpayers. The high-rate taxpayer may be able to divert income to a low-rate taxpayer or convert highly-taxed income into a lowly-taxed form. But this is pointless unless the high-rate taxpayer can be recompensed in a lowly-taxed form for diverting or converting his or her income into a low-tax category. The income must come back in a low-tax form. The benefit must also exceed the transaction costs. This is the third necessary condition for tax arbitrage.
o Since all tax systems have tax bases (The thing or amount to which a tax rate applies.

To collect income tax, for example, you need a meaningful definition of income. Definitions of the tax base can vary enormously, over time and among countries, especially when tax breaks are taken into account. As a result, a country with a comparatively high tax rate may not have a high tax burden (Total tax paid in a period as a proportion of total income in that period. It can refer to personal, corporate or national income. ) if it has a more narrowly defined tax base than other countries. In recent years, the political unpopularity of high tax rates has lead many governments to lower rates and at the same time broaden the tax base, often leaving the tax burden unchanged. )that are less than comprehensive because of the impossibility of defining and measuring all economic income, tax arbitrage and avoidance is inherent in tax systems. Examples of Tax Arbitrage/Avoidance The simplest form of arbitrage involves a family unit or a single taxpayer. If that family unit or taxpayer faces differences in tax rates (condition 1 above), and condition 2 above applies, then the third condition automatically holds.

This conclusion follows because people can always compensate themselves for converting or diverting income to a low tax rate. An example of such simple tax arbitrage involving a family unit is income splitting through, for example, the use of family trust. An example of simple tax arbitrage involving a single taxpayer is a straddle whereby a dealer in financial assets brings forward losses on, say shares, and defers gains while retaining an economic interest in the shares through use of options. Transfer pricing and thin capitalization practices through which non-residents minimize their tax liabilities are more sophisticated examples of the same principles. Multi-party arbitrage is more complex; the complexity is made necessary by the need to meet condition 3 above, that is, to ensure a net gain accrues to the high-rate taxpayer. In the simpler cases of multi-party income tax arbitrage, this process normally involves a tax-exempt (or tax-loss or tax-haven) entity and a taxpaying entity. Income is diverted to the tax-exempt entity and expenses are diverted to the taxpaying entity. Finally, the taxpaying entity is compensated for diverting income and assuming expenses by receiving non-taxable income or a non-taxable benefit, such as a capital gain.

Over the years many have indulged in numerous examples of such tax arbitrage using elements in the legislation at the time. Examples are finance leasing, non-recourse lending, tax-haven(a country or designated zone that has low or no taxes, or highly secretive banks and often a warm climate and sandy beaches, which make it attractive to foreigners bent on tax avoidance and evasion ) ‘investments’ and redeemable preference shares. Low-tax policies pursued by some countries in the hope of attracting international businesses and capital is called tax competition which can provide a rich ground for arbitrage. Economists usually favour competition in any form. But some say that tax competition is often a beggar-thy-neighbor policy, which can reduce another country’s tax base, or force it to change its mix of taxes, or stop it taxing in the way it would like.

Economists who favour tax competition often cite a 1956 article by Charles Tiebout (1924-68) entitled “A Pure Theory of Local Expenditures”. In it he argued that, faced with a choice of different combinations of tax and government services, taxpayers will choose to locate where they get closest to the mixture they want. Variations in tax rates among different countries are good, because they give taxpayers more choice and thus more chance of being satisfied. This also puts pressure on governments to be efficient. Thus measures to harmonize taxes are a bad idea. There is at least one big caveat to this theory. Tiebout assumed, crucially, that taxpayers are highly mobile and able to move to wherever their preferred combination of taxes and benefits is on offer.

Tax competition may make it harder to redistribute from rich to poor through the tax system by allowing the rich to move to where taxes are not redistributive. Tactics Used by Tax Evaders Moonlighting Tax evasion at its simplest level merely involves staying out of the tax system altogether. The Revenue deploys small teams of volunteer officers to carry out surveillance to track down moonlighters. Early success was followed up by the deployment of compliance officers in virtually every tax office. Revenue Investigation Officers routinely scan advertisements in local newspapers or shop windows and even before the advent of the modern personal computer they frequently had access to reverse telephone directories to track down moonlighters from bare telephone number details. They also study bank and other financial institutions deposit and loans databases, customs records, and star class hotel bookings for private functions and ceremonies to identify rich individuals who maybe evading taxes.

Non Extractive Fraud Alternatively it can arise because the tax base is less than comprehensive, for example, because not all economic income is subject to income tax. ï?~ An ability to exploit the difference in tax by converting high-tax activity into low-tax activity is required. If there are differences in tax rates, but no ability to move from high to low-tax, no arbitrage is possible. ï?~ Even if these two conditions are met, this does not make tax arbitrage and avoidance possible. The tax system may mix high and low-rate taxpayers. The high-rate taxpayer may be able to divert income to a low-rate taxpayer or convert highly-taxed income into a lowly-taxed form. But this is pointless unless the high-rate taxpayer can be recompensed in a lowly-taxed form for diverting or converting his or her income into a low-tax category. The income must come back in a low-tax form. The benefit must also exceed the transaction costs. This is the third necessary condition for tax arbitrage. Since all tax systems have bases that are less than comprehensive because of the impossibility of defining and measuring all economic income, tax arbitrage and avoidance is inherent in tax systems. This involves profit switches or timing differences, for example:

o Post dating Receipts
o Ante dating Expenditure
o Hidden Reserves
o Incorrect accounting of transactions such as showing an income as a payable.
o Stock manipulation Perhaps the most common place method seen in practice is the manipulation of stock to produce the desired “profit”.

It is not unknown for the evaders’ Accountant to be involved – putting at risk the livelihood and, if the amount involved is significant, personal liberty! The most blatant case of this kind is where the Accountant virtually treated this as year end tax planning. Based upon the formal disclosures made by the evader under the Hansard procedure to the Inland Revenue (in which he implicated the Accountant and in connection with an account in a false name also his Bank Manager), the following scene can be recreated: “Studying the draft accounts the Accountant did a quick calculation to work out what range of figures could be used for closing stock in hand without giving rise to suspicion. He then apparently discussed with the client the impact on net profit of reducing Closing Stock.

Arrangements were then made for the audit to take place and in the meantime some stock was moved off site! “The Accountant and Bank Manager who assisted the evader are both guilty of conspiracy to defraud – it matters not that they made no financial gain themselves. Extractive Fraud This might take the form of Suppressed receipts or inflated outgoings: Suppressed Receipts Typically these involve defected mainstream takings and often an undisclosed bank account. However the more resourceful evader may take advantage of special arrangements or unexpected receipts: Where the proprietor or director personally deals with some customers it may be possible for cheques to be made out in a manner which facilitates diversion. Alternatively cheque substitution may be used, such that the otherwise “off record sale” cheque is banked and an equivalent amount of “on record cash” is extracted.

It is not unknown for late cash payment of credit sales to bypass the bookkeeping system with the debt subsequently being written off as bad. Unexpected receipts always present a good opportunity for deflection. For example:

1. Scrap sales
2. Insurance or bad debt recoveries
3. Refunds, rebates or discounts
4. Returned goods sold for cash, disposal of fully written down assets and windfalls in general.

The evader may take advantage of a new business opportunity, which remains hidden, and off record. Examples of this seen in practice include:

1. the dentist with three practices of which only two were discloses
2. the off record sale of hitherto obsolete car parts to the burgeoning classic car market Inflated Purchases & Expenses Where the ability to deflect receipts is too difficult the evader might draw cash from the business bank account and disguise such withdrawals as some form of legitimate business expense. In practice this often involves the use of “ghost” employees or fictitious outgoings to cover such extractions. Fictitious outgoings have to employ the use of false invoices. These might take the form of altered invoices, photocopied or even scanned “blanked” versions of genuine invoices, completely bogus invoices or even blank invoices supplied by an associate.

Another approach seen in practice involved the use of a seemingly unconnected off shore company to raise invoices for fictitious services. To hide the true ownership of the off shore company the evader uses a “black hole” trust to hold the shares. Essentially this involved a compliant non-resident trustee and “dummy” settler – the trustee providing “stooge” directors as part of the arrangements.

Employment Tax Evasion Schemes Employment tax evasion schemes can take a variety of forms. Some of the more prevalent methods of evasion include pyramiding, employee leasing, paying employees in cash, filing false payroll tax returns or failing to file payroll tax returns. Pyramiding “Pyramiding” of employment taxes is a fraudulent practice where a business withholds taxes from its employees but intentionally fails to remit them to the relevant departments. Businesses involved in pyramiding frequently file for bankruptcy to discharge the liabilities accrued and then start a new business under a different name and begin a new scheme. Employment Leasing Employee leasing is another legal business practice, which is sometimes subject to abuse.

Employee leasing is the practice of contracting with outside businesses to handle all administrative, personnel, and payroll concerns for employees. In some instances, employee-leasing companies fail to pay over to the authorities any portion of the collected employment taxes. These taxes are often spent by the owners on business or personal expenses. Often the company dissolves, leaving millions in employment taxes unpaid. Paying Employees in Cash Paying employees in whole or partially in cash is a common method of evading income and employment taxes resulting in lost tax revenue to the government and the loss or reduction of future social benefits. Filing False Payroll Tax Returns or Failing to File Payroll Tax Returns Preparing false payroll tax returns understating the amount of wages on which taxes are owed, or failing to file employment tax returns are methods commonly used to evade employment taxes. Payments of Benefits These include free benefits such as personal entertainment, excessive allowances for foreign travel, provision of educational schemes (foreign education) to only preferred employees, car and driver paid by company etc are simple examples.

Conclusion

I hope that I have made clear the difference between doing things right and legitimately and in a fraudulent manner. Whether you are a taxpayer or a consultant it is important to make sure that you understand the nuances of good tax planning. Whilst it is understood that tax planning is becoming more difficult and there is only a thin line between what is right and wrong it obviously requires the expert to do the needful. However be careful not to be tricked by those who claim to be experts in tax planning when they are mere computational experts.

General Tax Strategies and Principles For the Independent Minded Person

General Tax Strategies

Tax planning is highly dependent on where you live, but there are general strategies that apply to tax systems in many countries. Please check with the tax code that applies to you – there may be more than one. The mindset surrounding taxes is important in understanding what the motivation behind a tax is. Taxes should be treated as the ongoing cost of making money. They should always be accounted for prior to making an investment, taking on employment or forming a business. It is not what you earn in revenue that matters, it is what you get to keep net of all expenses – and this includes taxes. If you think in this format, you will know what to expect from your tax situation, and you will know if the activity you are undertaking is worthwhile. Going to work should also be viewed this way. Take note of how much money you get to keep after taxes. If you are getting a promotion, or choosing between two jobs, the one with the most income after all taxes and expenses should be the one you choose. This assumes that everything else about the two choices is the same, which is very rarely the case. The purpose of the prior statement is to raise awareness of strategic thinking when it comes to taxes. If you are going to take a contract job or run a business versus salaried employment, these choices become more important. The next paragraphs outline general concepts that would apply to most situations because they are fundamental to how a tax system is constructed.

Timing is Important

You will notice that taxes are always filed in annual periods, or quarterly periods if you report or pay quarterly. Notice as well that the more money you earn, the higher the percentage of tax you pay on that extra money you earn. This is what is called a “progressive tax system” which is how the Canadian tax code is constructed. If tax rates are flat over all incomes, meaning that the percentage of taxes paid are the same regardless of how much money you earn, this strategy would not apply in the same way. In a progressive system, timing is important because if you claim $100,000 in income in a single year, you will pay more taxes than claiming $100,000 in income spread over 2 years. If you have an option to claim income over more tax periods, you will pay fewer tax dollars.

Are you getting a tax refund? Using the idea of the annual period, whatever is deducted throughout the year is then matched with a calculation that is done at the end of the tax period. If you paid more throughout the period than you are required to pay, you would get a refund. If you pay less than the amount required, you would have to pay an additional payment when the end of the period arrives. If you are deducting a lot of taxes in advance, you would tend to get a refund. The downside is that you are not earning interest on the money. Interest rates are very low now, so this may not be worth thinking about, but as rates rise, giving the government money in advance will be more expensive. If you are a savvy investor, and you can invest these taxes for a portion of the year before remitting them to the government, this is income you would not have otherwise been able to generate. If you are paying an additional payment at the end of the year, you are holding onto your money longer. Other factors to consider on this topic are whether paying a larger tax payment at the end of the tax year is disruptive to your cash flow. If you are borrowing money to pay your taxes, this is an additional cost which is over and above your required tax payment.

RRSPs and Tax Timing

Registered Retirement Savings Plans and related accounts like the RESPs and RRIFs are tax timing vehicles. You would get a tax deduction upfront and pay taxes later – in the year that you take money out of the tax shelter. Keep in mind that your tax situation when you put money into the tax shelter can be different than when you take money out. The tax code itself may also be different at both times. This is hard to plan for, but it is usually assumed that taxes will rise as time goes by. The ideal scenario is to contribute to an RRSP when your income is at its highest, and withdraw it when your income is at its lowest. This would translate into the biggest deduction upon deposit, and smallest tax burden upon withdrawal. The frequency of your withdrawal can also affect how much taxes you pay within the tax year. The larger the lump sum withdrawals, the higher the rate of taxes charged upfront. When the tax year ends, the taxes payable will be adjusted to the same amount regardless of this initial deduction. Throughout the year however, you can either pay the tax man in advance, or pay the tax man more at year end. If you are able to generate return within the tax year, delay the tax payment as long as you can and generate that extra income.

Type of Income and Associated Risk is Important

The tax code in Canada generally looks at three types of income. These are income (working as an employee and interest earned on guaranteed securities fits here), dividends, and capital gains. These three buckets represent 3 different levels of risk, and so there are 3 different sets of rules for each. Generally speaking, the more risk of loss that you have in creating this income, the less taxes you will pay, and the more likely it is that you can offset losses with your gains. Another aspect of these rules is that tax treatment of income is generally limited to the year in which it was earned. Once the year is over, you cannot revisit the taxes paid unless there is some error or recalculation due to a retroactive tax code adjustment. This concept is true for dividends as well. Once they are earned in a specific year, you generally cannot offset taxes in future years. With capital gains however, you are able to adjust past tax returns and future tax returns by carrying gains or losses to other years and “smoothing out” the amount of taxes paid over your lifetime. This is allowed because in order to incur capital gains, you will likely also incur capital losses, and by not allowing you to offset these losses, you are being taxed in an unbalanced way. The tax rate itself is highest for income, lower for dividends, and lower still for capital gains. Take note that these concepts hold true if you are talking about working and living in the same country. Once you get into foreign jurisdictions (like US dividends from US companies being paid to a Canadian), the rules may change. If you are affected by this situation, ask your tax preparer specifically about the situation you are in. As an example, if you are a Canadian being taxed on U.S. dividends, ask about the tax treatment in this specific situation. A U.S. resident earning that same dividend and in the same income scenario would be paying a different amount of taxes. Each pair of countries that are relevant to a situation (the country you are a resident or citizen of, and the country where the income is generated) are the countries I would inquire about. The situation will be different for each set of countries, and would apply if you earn income in more than two tax jurisdictions.

Federal and Provincial Taxes Are Important

In Canada, there are federal taxes and provincial taxes. The provincial taxes are calculated as a percentage of the federal taxes, so it is harder to predict the effect of these taxes in total. The best way to know how much taxes you are paying is to look at your historical tax returns and look at the entire amount paid in taxes. Other ways to prepare for this situation are to use tax calculators or ask your tax preparer to estimate the combined effect. People tend to look at the federal rates but underestimate that there is also a provincial tax rate on top of that. Related to this idea, as you lower your taxable income, you will lower your federal taxes payable, and your provincial taxes payable. If your income is high, the provincial taxes will go up at a faster rate in a scenario where the provincial tax rates are progressive.

Tax Credits

If you are eligible for tax credits, use them as much as you can. These can change with every budget, and they sometimes expire – so an up to date source of tax information is highly advised here. Remember as well that governments issue tax credits to encourage investment in a sector, or change consumer buying patterns. When you see that the government is losing too much money from a credit, or the desired influence has largely been achieved, the credit will likely get modified or deleted. Make sure to look at the tax credit with respect to your whole tax situation. If you have to give up some other benefit to get the credit, or spend money you wouldn’t have otherwise spent, this credit may not be worthwhile. If you are spending money only to generate tax deductions because it is legal, examine whether you really need to spend this money. As an example, if you spend $100 to generate an expense, you will receive $30 in taxes back. If that $100 was not spent in the first place because you didn’t really need to spend it, you would keep $100 more. If you are spending $100 no matter what, and you are able to legally expense it, then you are saving that extra $30. Taxes should not drive your financial decisions for the most part, but they can take a situation that is generally neutral, and skew it to a desired outcome. As the person paying the taxes, you should consider whether you would make this transaction with and without the tax implications, and see which outcome works the best for you. This concept would apply to taxes in general, but especially to tax credits.

Tax Strategies Outside the Scope of the Tax Code

Be mindful of tax strategies that save taxes but are outside the scope of the tax code. These are not deemed illegal initially, but if they get too popular, the government may make an official statement that it does not recognize the tax strategy and it is therefore invalid. A good illustration of this scenario is the charity tax credits where people would give money to a charity and earn a greater return that what they contributed. The Canada Revenue Agency eventually shut down this idea as it was deemed abusive. Another example of this situation is the first years of the Tax Free Savings Account (TFSA). There were issues surrounding transfers between the TFSA and the RRSP, and since specific conditions were not stipulated in the tax code, these transfers were assumed to be legal. It turned out that people were charged taxes in hindsight, and the issue was resolved by modifying the TFSA rules at later years. The safest thing to do in these cases is not to delve into these gray areas. If you believe in doing so, acknowledge that there risks and find a tax lawyer who has knowledge in the specific tax idea. Should you get audited or challenged in court, you will have the resources you need.

Running a Business and Taxes

Generally speaking, if you can operate a business versus working for an employer, having a business would allow you to deduct more expenses, and pay fewer taxes all else being equal. There are many implicit assumptions in this statement. The first one is that you can make the identical income at the same time frequency as working as an employee. If you don’t think you can generate income consistently, it may not be worth to have a business. The truth is that business income tends to be lumpy and unpredictable. The second one is the deductions. Small businesses pay fewer deductions and less EI, but would pay more in CPP. Insurance may cost more as well if you choose to have it as a business versus being an employee, since the employer subsidizes the insurance costs. Within this point is the assumption that you are running a business at home. Your home expenses would be partially deductible, leading to less tax paid. If you run your business from another location, you will incur more expenses, and the tax situation may be better or worse depending on the net effect of your revenue and expenses. The third point of clarification is that there are different tax rules between being a contractor and a small business. Lastly, the type of business is important. It is fairly simple to be a sole proprietor, but to incorporate involves different costs and commitments. Yes, the corporate tax rate is generally lower than for individuals. However, corporations take more time to operate, have setup costs, legal costs and reporting costs that sole proprietors don’t have. Corporations would also have separate HST numbers which is another layer of record keeping over and above that of a sole proprietor. Keep in mind that complexity in general involves more time and effort as well. To incorporate for legal reasons or strategic reasons is a whole other matter. Professionals should be consulted before considering forming a corporation.

Tax System, Rules And Rates In Albania 2012

Taxes in Albania are grouped into three main categories: indirect taxes (VAT, excise, gambling and other indirect taxes), direct taxes (income tax, personal income taxes, taxes on capital); local taxes, and social and health security contributions. These three categories are under authority like below:

National Taxes, administered by the Central Tax Administration and Customs Administration include:

Indirect taxes include: Value added tax; Excise; Taxes on gambling, casinos and hippodromes;

Direct taxes include: Income tax; National taxes; Other taxes, which are defined as such by special law, and Customs taxes.

Social and health security contributions, as defined in the social insurances law

Local taxes and tariffs administered by Local Tax Administration include: Local tax on small business; Tax on immovable property, which includes tax on buildings and agricultural land; Tax on hotel accommodation; Tax on impact of new constructions upon infrastructure; Tax on transfer of ownership right on real estate; Annual tax for vehicle registration; Tax for occupation of public space; Board tax; Temporary taxes; Registration tariff for various activities; Cleaning and waste disposal tariff; Vehicle parking tariff; Tariff for services.

How is going on the Taxation of commercial companies?
Each individual, who is a partner in a commercial company, is responsible for the company’s tax liabilities to the tax administration, according to provisions in the company charter. According to commercial registry, over 95 percent of companies are limited liability companies. The remainder is joint stock companies, partnerships and less than 0.5 percent is limited partnerships. At the moment a company is created and starts its economic activity, it is responsible for:

– Calculation of VAT and timely declaration and payment;
– Payment of advance tax installments for profit tax to pay every month;
– Calculation, timely declaration and payment of tax on incomes from employment for employers and employees;
– Calculation, timely declaration and payment of social and health insurances contributions;
– Monthly payment of advance income tax installments in time;
– Withholding and payment of withheld tax, under obligation from the Law On Income tax;
– Calculation, timely declaration and payment of taxes according to specific activity for gambling, casinos and hippodromes;
– Calculation, timely declaration and payment of excise under specific law;
– Calculation, timely declaration and payment of national taxes and local taxes.

In order to calculate taxes, taxpayers who are subject to VAT or profit tax keep registers, accounting records, books and financial information and issue tax receipt or tax coupon, in accordance with relevant laws and regulations pursuant to them. Taxpayers keep their accounts in accordance with provisions of the law “On accounting and financial statements” and act pursuant to that law in accordance with IFRS principles. In order to register economic transactions related to taxes, taxpayers can also use books, records or documents specified in specific tax laws and respective regulation provisions. Taxpayers are required to use basic documentation, including tax invoice, in accordance with tax legislation and relevant legal provisions.

What Tax exemption are applied?
Albania’s tax regime is considered by far one of the most important incentives for foreign investment as it is the lowest in Europe; however, the tax system as such does not discriminate against or in favor of foreign investors.

Likewise, legislation relating to the public procurement process makes little distinction between foreign and domestic companies, as many activities in Albania require licensing within the territory. The procedures for obtaining a license are, however, the same for national and foreign companies. The government to date has not screened foreign investments and provided little in the way of tax, financial or other special incentives.

The Value Added Tax
The majority of goods and services are subject to VAT at a standard rate of 20 per cent, although certain exemptions apply (such as for financial services, postal services, non-profit organization supplies, packaging and materials used in drug production, supplies of electronic and written media for advertising, supplies of services at casinos and hippodromes (race tracks), sales of newspapers, magazines and advertisement services in them, as well as certain hydrocarbon operations).

According to the instruction of the Minister of Finance (No. 17, 2008), the most significant incentives for investors in Albania are as follows:

– VAT credit at the rate of 100 per cent for importers of machinery and equipment which will serve entirely their taxable economic activity;
– exemption of VAT for export of international services;

The tax export regime can be considered a kind of investment incentive for both foreign and national entrepreneurs, and is applicable to all Albanian products destined for export outside the Albanian customs territory. The export VAT rate it is 0 per cent. Exporters can benefit from a VAT credit for purchases made on behalf of their exports.

Overall, if the tax credit for a taxation period is higher than the VAT applicable in that period, taxpayers have the right to use the credit surplus for the following taxable period. Taxable persons have the right to request a reimbursement of the credit surplus when they have a taxable credit amount over three months that is above 400,000 Albanian Leks. As stated above, and since they are essentially exporters, investors are entitled to VAT reimbursement on the purchase of domestic goods or raw materials when it is for production purposes.

The Corporate taxation
Definition of Residence
A company is considered resident in Albania if it has its legal seat or place of effective management in Albania. Further, partnerships and legal entities with a permanent establishment in Albania would be considered resident taxpayers. Residents must register with the National Registration Center (NRC).

Taxable Basis
Residents are taxed on their worldwide income; non residents are taxed only on their Albanian- source income.

Taxable income
Taxable income of residents includes business profits, as well as dividends, interest, and realized capital gains. Taxable profit is the difference between gross profit and related expenses. The determination of the taxable profit is generally based on the profits shown on the financial statements.

Tax income Rate
The rate of income tax is a flat tax of 10% as of January 1st, 2008.

Taxation of dividends received by residents
Dividend income is generally considered taxable income, unless the participation exemption or a double tax treaty relief is applicable.

Participation exemption: Resident companies – Dividends and distribution of earnings are excluded from a resident’s taxable profit when dividends and earnings are distributed from resident companies or partnerships which:

– are subject to corporate income tax; and
– the beneficiary resident’s shareholding comprises at least 25%, in value or number, of stock capital or voting rights, while for partnerships at least 25% of the initial capital.

However, if the recipient shareholder has ownership of less than 25% of the distributing company, the dividends are included in the taxable income of the recipient shareholder.

Participation exemption: nonresident companies – No participation exemption is in place for holding of foreign companies. Consequently, dividends received from foreign companies would be included in taxable income. Taxation of dividends paid to nonresidents – Dividend income distribution to a nonresident is subject to a withholding tax of 10%, unless a double tax treaty provides for a lower rate.

Capital gains
Realized capital gains are considered as taxable income and are taxed together with other income, at 10% on a net basis.

Losses
Losses can be carried forward for three consecutive years, unless there is a change of ownership of 25% of the company’s shares. Carry-back of losses is not permitted.

There’s no Surtax in Albania.

Alternative minimum tax
None

Reign tax credit
Double taxation is avoided through tax treaties. Albania currently has 25 treaties in effect with other countries.

Tax Treaties with Albania:
Poland (1995), Romania (1995), Malaysia (1995), Hungary (1996), Turkey (1997), Czech Republic (1997), Russian Federation (1998), Macedonia (F.Y.R.O.M.) (1999), Croatia (1999), Italy (2000), Bulgaria (2000), Sweden (2000), Norway (2000), Greece (2001), Malta (2001), Switzerland (2001), Moldova (2004), Belgium (2005), China (2006), France (2006), Netherlands (2006), Egypt (2006), Serbia and Montenegro (2006), Korea (2008), Austria (2009), and Latvia (2009).

Holding company regime
No
Tax Incentives
Occasional tax relief from Corporate Income
Tax is granted for selected projects on a case-by-case basis. These projects may include investments channeled to public services, infrastructure projects, as well as tourism and oil industries.

Withholding tax
Withholding tax is applicable to dividend, interest, and royalty payments, as well as certain other types of Albanian-source income earned by nonresidents.
Dividends are subject to a 10% withholding tax rate, unless the rate is reduced under an applicable tax treaty.

Interest is taxed at a 10% withholding tax rate, unless the rate is reduced under an applicable tax treaty.

Royalties are subject to a 10% withholding tax rate, unless the rate is reduced under an applicable tax treaty.

Other Albanian-source Income
A withholding tax of 10% is applicable to the gross amount of: a) technical service fees; b) management fees; c) payments for construction, installation, assembly or related supervisory work; d) rental payments; and e) payment for the performance of entertainment activities, which are made to nonresident taxpayers.

Filing Requirement
Withholding tax must be paid no later than the 20th day of the month following the month the remittance upon which the withholding tax is assessed. The payer of such amounts is responsible for retaining and paying the tax on the account of the tax authorities.

Branch remittance tax
None

Other taxes on corporations
Capital duty
None

Real property tax
Municipalities levy taxes based on the occupation of real property. A real estate tax on construction projects is levied on the value of a new investment at a rate of 2% to 4% in Tirana and 1% to 3% in other municipalities. Property tax is also applicable to agricultural land at rates varying from ALL 700 to ALL 5,600 per hectare, depending upon their use. A tax credit of 50% may be available for certain rural projects.

Beneficiary and Fiduciary Liability for Income, Gift and Estate Taxes

It can be either a blessing or a curse to be appointed as the Personal Representative of an estate or Trustee of a trust (collectively a “Fiduciary”). One of the most over looked aspects of the job is the fact that the U.S. Government has a “general tax lien” on all estate and trust property when a decedent leaves assessed and unpaid taxes and a “special tax lien” for estate taxes on a decedent’s death. As a result, when advising a Fiduciary on the estate and trust administration process it is important to inform them that with the responsibility also comes the potential for personal liability.

On many occasions a Fiduciary may be placed into a position where assets passing outside the probate estate (life insurance, jointly held property, retirement accounts, and pension plans) or trust, over which they have no control, constitute a substantial portion of the assets (real property, stocks, cash, etc.) subject to estate taxation. Without the ability to direct or assume control of the assets the Fiduciary may have both a liquidity problem and lack of means to satisfy the estates tax (income or estate) obligation. For this reason alone, a Fiduciary should be very reluctant to distribute any funds to a beneficiary before all statute of limitation periods expire for the Internal Revenue Service (“IRS”) to assess a tax deficiency.

Liability for Income and Estate Taxes:

Internal Revenue Code (“IRC”) §6012(b) holds a Fiduciary responsible for filing the decedent’s final income and estate tax returns. IRC §6903(a) further establishes a Fiduciary’s responsibility for representing the estate in all tax matters upon filing the required Notice Concerning Fiduciary Relationship (IRS Form 56). Under IRC §6321, when the tax is not paid an IRS lien will spring into being. When an estate or trust possesses insufficient assets to pay all its debts, federal law requires the Fiduciary to first satisfy any federal tax deficiencies before any other debt (31 U.S.C. §3713 and IRC §2002).

A Fiduciary who fails to abide by this requirement will subject themselves to personally liability for the amount of the unpaid tax deficiency (31 U.S.C. §3713(b)). An exception arises when an individual has obtained an interest in the property that would prevail over the federal tax lien under IRC §6323 (United States v. Estate of Romani, 523 U.S. 517 (1998)). When there are insufficient estate or trust assets to pay a federal tax obligation, as a result of the Fiduciary’s actions, the IRS may collect the tax obligation directly from the Fiduciary without regard to transferee liability (United States v. Whitney, 654 F.2d 607 (9th Cir. 1981)). If the IRS determines a Fiduciary to be personally liable for the tax deficiency it will be required to follow normal deficiency procedures in assessing and collecting the tax (IRC §6212).

Prerequisites for Fiduciary Liability:

Under IRC §3713, a Fiduciary will be held personally liable for a federal tax liability if the following conditions precedent are satisfied: (I) the U.S. Government must have a claim for taxes; (ii) the Fiduciary must have: (a) knowledge of the government’s claim or be placed on inquiry notice of the claim, and (b) paid a “debt” of the decedent or distributed assets to a beneficiary; (iii) the “debt” or distribution must have been paid at a time when the estate or trust was insolvent or the distribution created the insolvency; and (iv) the IRS must have filed a timely assessment against the fiduciary personally (United States v. Coppola, 85 F.3d 1015 (2d Cir. 1996)). For purposes of IRC §3713, the term “debt” includes the payment of: (I) hospital and medical bills; (ii) unsecured creditors; (iii) state income and inheritance taxes (conflict between U.S. Blakeman, 750 F. Supp. 216, 224 (N.D. Tex. 1990) and In Re Schmuckler’s Estate, 296 N.Y. 2d 202, 58 Misc. 2d 418 (1968)); (iv) a beneficiary’s distributive share of an estate or trust; and (v) the satisfaction of an elective share. In contrast, the term “debt” specifically excludes the payment of: (I) a creditor with a security interest; (ii) funeral expenses (Rev. Rul. 80-112, 1980-1 C.B. 306); (iii) administration expenses (court costs and reasonable fiduciary and attorney compensation) (In Re Estate of Funk, 849 N.E.2d 366 (2006)); (iv) family allowance (Schwartz v. Commissioner, 560 F.2d 311 (8th Cir. 1977)); and (v) a “homestead” interest (Estate of lgoe v. IRS, 717 S.W. 2d 524 (Mo. 1986)).

In order to collect the federal tax deficiency the IRS possesses the option to either file a lawsuit against the Fiduciary in federal district court, pursuant to IRC. §7402(a), or issue a notice of fiduciary liability under IRC § 6901(a)(1)(B and commence collection efforts. The statute of limitations for issuing a notice of fiduciary liability is the later of one year after the fiduciary liability arises or the expiration of the statute of limitations for collecting the underlying tax liability (IRC § 6901(c)(3)).

Before collection efforts can be started the IRS must first establish that the decedent’s estate or trust is insolvent (debts exceed the fair market value of assets) or possesses insufficient assets to pay the outstanding tax liability. “Insolvency” can only be established when the estate or trust possesses insufficient assets under the Fiduciary’s custody and control to satisfy the tax liability. With regard to non-probate or trust assets included in a decedents gross estate, IRC §2206-2207B empowers a Fiduciary to obtain from the beneficiary the portion of the estate tax attributable to those assets.

Preference Requirement and Knowledge of Outstanding Tax Obligations:

While the IRS may pursue collection of an estate tax deficiency from the beneficiaries, the Fiduciary will only retain a right of subrogation if the IRS elects to pursue collection of the tax deficiency against them. Under IRC §6324, the IRS may seek collection of the federal tax deficiency from the Fiduciary in possession of the assets on which the tax applied, not to exceed the value of the assets transferred to any beneficiary. However, if the Fiduciary had no knowledge of the debt, they will not be liable for more than the amount distributed to the beneficiaries or other creditors, or for taxes discovered subsequent to any distributions (Rev. Rul. 66-43, 1966-1 C.B. 291). Regardless of the circumstances, a Fiduciary’s failure to file a federal tax return will subject them to personal liability for the unpaid tax.

The burden of proof will then rest with the Fiduciary to prove their lack of knowledge of the unpaid tax (U.S. v. Bartlett, 2002-1 USTC ¶60,429. (C.D. Ill. 2002)). Once this element is established the burden will shift back to the IRS (Villes v. Comr., 233 F.2d 376 (6th Cir. 1956); Estate of Frost v. Commissioner, T.C. Memo. 1993-94). If the liability pertains to income or gift taxes relating to years before the decedent’s death, a court may require the Fiduciary to have actual or constructive knowledge of the liability before holding them personally liable for the unpaid tax (U.S. v. Coppola, 85 F.3d 1015 (2d Cir. 1996)).

Statutes of Limitation:

Under IRC §6901 and §6501 the statutory period for assessing personal liability against a Fiduciary tracks the same as the underlying tax. The limitation period is: (I) three years from the date of a tax returns filing or the date the tax return is due (if filed early); (ii) six years if there is a substantial omission (25% or more) of gross income, gift or estate assets; or (iii) no limit if the IRS can prove fraud. Under IRC §6502(a), once the IRS makes a tax assessment it has ten (10) years to collect the tax.

METHODS FOR REDUCING FIDUCIARY LIABILITY

A Fiduciary may only make a partial distribution to beneficiaries or creditors without concern of personal liability for estate tax deficiencies if sufficient assets are retained to pay all tax liabilities (including potential interest and penalties).

Income and Gift Taxes:

The first step requires the Fiduciary to file IRS Form 4506, Request for Copy or Transcript of Tax Form, with the IRS. The response received from the IRS will educate the Fiduciary as to which tax returns (income, gift, etc.), if any, were filed by the decedent prior to his or her death. The request should include the Fiduciary’s letters of administration, if applicable, and a Power of Attorney (IRS Form 2848).

To expedite the process, IRC § 6501(d) authorizes a Fiduciary to file IRS Form 4810, Request for Prompt Assessment, to request a prompt assessment and review of all tax returns filed by the decedent with the IRS. The Form 4810 must detail the following: (I) type of tax; (ii) tax periods covered; (iii) name, social security or EIN on each return; (iv) date the returns were filed; and (v) letters of administration or comparable authority to act on behalf of the estate or trust. Filing Form 4810 will shorten the statute of limitations period for the tax return from three years from the date of filing or due date of the return to eighteen (18) months from the date of its filing with the IRS. It is important to note that the shortened statute of limitations period will not apply to: (I) fraudulent tax returns; (ii) unfiled tax returns (IRC §6501(c)); (iii) any tax return with “substantial omissions” (IRC §6501(e)); or (iv) any tax assessment described in IRC §6501(c).

Once the decedent’s federal income tax return(s) has been filed with the IRS the Fiduciary may file a written application requesting release from personal liability for income and gift taxes. The IRS will then be limited to nine (9) months (the “notification period”) to notify the Fiduciary of any tax due. Under IRC §6905, upon expiration of the notification period, the Fiduciary will be discharged from personal liability for any tax deficiency thereafter found to be due and owing. The application should be filed with the IRS officer with whom the estate tax return was filed (or, if no estate tax return was required, to the IRS office where the decedent’s final income tax return was filed).

Estate Taxes:

A Fiduciary administering an insolvent estate or trust may also consider filing, pursuant to 28 U.S.C. §2410(a), a federal district court quiet title action against the U.S. Government. The District Court will only have jurisdiction to address procedural challenges and not the underlying IRS tax liability (Walker v. U.S. (N.J. 2-29-2008) and Robinson v. United States, 920 F.2d 1157 (3d Cir. 1990)). In Estate of Johnson v. U.S., 836 F.2d. 940 (5th Cir. 1988), a Texas fiduciary argued that he had a right to a quiet title action to determine if administration and funeral expenses had priority over federal tax liens. However, the Fiduciary should be cognizant that any quiet title court order may not protect them from an IRS assertion of personal liability under §3713(b).

DISCHARGE FROM PERSONAL LIABILITY

Estate Taxes:

IRC §2204 authorizes a Fiduciary to submit a written request for discharge from personal liability from the federal estate tax. The IRS has nine months from the filing of the request, when filed after the estate tax return, to notify the Fiduciary of any estate tax due. Upon payment of the tax (the IRS will issue form 7990) and expiration of the nine-month period the Fiduciary will be discharged from personal liability for any estate tax deficiency. It is important to recognize that IRC §2204 only discharges the Fiduciary from personal liability and will not shorten the time for assessment of tax against the estate or any transferee of estate assets.

IRC §6903 provides that a judicial discharge is insufficient to relieve a Fiduciary of subsequent estate tax liabilities. Only the filing of IRS Form 56, Notice Concerning Fiduciary Relationship, informing the IRS of judicial discharge or other legal termination will terminate the Fiduciary duties. As a protective measure, most Fiduciary’s require beneficiaries to enter into separate agreements guaranteeing indemnification for any subsequent tax deficiencies in exchange for the distribution of the estate or trust’s assets to them.

Income and Gift Taxes:

IRC §6905 provides the method for a Fiduciary to be discharged from personal liability for income and gift taxes of a decedent. The Fiduciary will be required to make written application (filed after the tax return with respect to such tax is made) on IRS Form 5495 for release from personal liability. Upon payment of the tax or expiration of a nine-month period (if no notification is made by the Secretary during this period) after delivery of the application for release the Fiduciary will be: (I) discharged from personal liability for any deficiency in such tax thereafter found to be due; and (ii) entitled to a written acknowledgment (IRS Form 7990A for gift taxes) of such discharge.

TRANSFEREE LIABILITY

Estate and Trust Taxes:

Every estate and trust beneficiary (heir, legatee, and devisee) must be appraised of their potential for personal liability for unpaid estate taxes under IRC §6901(a)(1) (probate estate) and §6324(a)(2) (non-probate assets included in the decedent’s gross taxable estate). Pursuant to IRC §6901, the liability of a transferee is similar to that of the transferor under §3713. A beneficiary’s transferee liability will be limited to the value of assets transferred to them (Commissioner v. Henderson’s Estate, 147 F.2d 619 (5th Cir. 1945)).

Gift Taxes:

Under IRC §2501, a donor (party making a gift) will bear primary responsibility for paying any tax liability associated with a gift. This will not preclude a donee, under IRC §6324, from being held liable for the applicable gift tax. Transferee liability will hold the donee personally liable for the applicable gift tax (the donor’s tax deficiency), up to the value of the gift, even if the gift received did not contribute to the unpaid gift tax liability (U.S. v. Botefuhr, 309 F.3d 1263 (10th Cir. 2002).

IRC § 6324 further provides that the tax lien shall remain in place for ten-years from the date the gifts are made. The liability will immediately arise once the donor fails to pay the applicable gift tax (Poinier v. Commissioner, 858 F.2d 917 (3d Cir. 1988)).

PROBATE LAW

Under state law, a claim for federal taxes (income, estate or gift) will not be subject to state probate statutes or the requirement that a creditor claim be filed in probate proceedings (U.S. v. Stevenson, 2001-2 USTC 50,371 (M.D. Fla. 2001)). The IRS can provide notice of the tax liability to the fiduciary by sending Form 10492. The federal tax obligation will then receive preference over all other claims against and obligations (state inheritance taxes, and other expenses) of an estate (Rev. Rul. 79-310, 1979-2 C.B. 404). As a result, even if the IRS fails to file a claim against an estate, the Fiduciary should actively assert the U.S. Government’s priority under IRC §3713.

State Statutes:

State probate statutes may be utilized to protect a Fiduciary by limiting the circumstances under which they will be required to either pay or deliver a devise or distributive share to a beneficiary. In Florida, the limitations include: (I) not earlier than five (5) months after the granting of letters of administration; and (ii) compelled, prior to final distribution, to pay a devise in money, deliver specific personal property, unless the personal property is exempt personal property. Even then, unless the beneficiary establishes that the assets will not be required for the payment of estate and inheritance tax, a claim (debts, elective share, expenses of administration, etc.), provide funds for contribution, or to enforce equalization in case of advancements. If the administration of the estate is not completed before the entry of an order of partial distribution (devise, family allowance, or elective share) a court may require the beneficiary to post a bond with sureties and require them to make contribution, plus interest, if it is later determined that there are insufficient assets.

Homestead Property:

Federal tax law, accept as provided under IRC §6334, Property Exempt from Levy, will preempt state exempt property statutes and constitutional homestead protection laws. The preemption will allow the IRS to impose a federal tax lien or levy on personal assets of an estate or trust for collection (In Re Garcia, 1D02-0279 (Fla. App. 5 Dist. 2002) or homestead property (Busby v. IRS, 79 A.F.T.R. 2d 97-1493 (S.D. Fla. 1997)).

IRC Section 6331 permits the United States to collect taxes of a delinquent taxpayer by levy on all property and rights to property unless exempt under section IRC §6334. IRC §6334 specifically provides that a “principal residence shall not be exempt from levy if a judge or magistrate of a district court of the United States approves in writing) the levy of such residence.”

Under Florida law, a Fiduciary is also obligated to notify the county property appraiser of a decedent’s death and their property’s ineligibility for the homestead tax exemption. F.S. §193.155(9) provides that a Fiduciary’s failure could result in the assessment of penalties and interest. In addition, if the property was not entitled to a homestead property tax exemption, the statute provides for the imposition of: (I) a lien against the real property; and (ii) imposition of taxes, interest, and a penalty equal to fifty (50%) percent of the unpaid taxes resulting from the incorrect classification.