December 1985
Vol 8 No 3
How appropriate as the Christmas season approaches that we recall that Joseph and Mary were on their way to Bethlehem to pay TAXES! Time is counting down until we too must ‘render unto Caesar‘ a portion of our own productivity. And neither Mary‘s delicate condition nor our own straits will deter the taxman from his appointed rounds. In this issue we‘ll concentrate on the current tax situation. Hopefully we‘ll find ways to slow the hemorrhaging to some degree both for this year and for 1986.
First of all, reflect that we‘re now paying higher taxes than at any other time in our history regardless what the Government says! Why? Possibly most of all because we allow government at all levels to waste our money. The Grace Commission documented literally thousands of examples of government inefficiency which cost American producers BILLIONS OF UNNECESSARY TAX DOLLARS. J. Peter Grace‘s book: ‘BURNING MONEY‘ can be bought at your local book store if you‘d like to see for yourself. It has had virtually zero impact on government spending practices. Rather than bringing our elected representatives to task, most of us have resorted to trying to wring as much of our taxes as possible back out of the system. We thus aid and comfort the massive bureaucracy responsible for waste.
Why doesn‘t the average person take action? Many times he doesn‘t even realize how much he‘s paying. He thinks his refund is some sort of bonus given by the government. He‘s never figured out that taxes collected in January are a tax free loan until they fall due. He‘s subjected to massive indoctrination which labels as a ‘TAX CHEAT‘ anyone who is audacious enough to try to salvage some of his profits for his own use. He‘s threatened with withdrawal of essential government services anytime he objects to paying his taxes. And he‘s made to feel guilty anytime he resists giving his money to others to spend.
Who pays taxes anyhow? 36% of all income taxes are paid by the top 6% of the population. The top 12% pay 48%. The top 3% pay 31%. Those earning $12,000 or less and who are by far the most voracious consumers of tax revenues after the bureaucrats who administer government programs pay only 6% of the total income tax tab. The Administrators and the staffs who dole out the funds are the biggest benefactors of our tax system. Yet no tax reform bill or budget proposal yet announced seeks to plug this hole in the bucket. Despite the proclamations of Jimmy Carter and Ronald Reagan who promised to reduce the size of government, this is the fastest growing sector in the American economy.
Is it any wonder that citizen‘s constitutional guarantees of liberty are so eagerly cast aside whenever tax matters are concerned? The presumption of innocence. Property rights. The expressed wishes of the Congress. The rulings of the Judiciary. None of these can hold sway against the IRS in its quest for money with which to feed the omnivorous budgets. As a result, government is the biggest employer, the biggest land owner, the biggest user of commercial space, the biggest winner in our economic struggle. It‘s a matter of survival. Without taxes there would be no funds with which to pay tax collectors and those who enjoy the good life as government employees. This includes those at state, county, and city government levels as well. Taxes at all levels are on the rise even as our economy continues to sink under the burden of relentless deficits.
IT‘S UP TO YOU TO MINIMIZE YOUR TAX BILL . . .PRUDENTLY.
Beware of year-end tax shelter scams. IRS computers are programmed to detect
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any extraordinarily juicy write-offs. A special team has been named to investigate them. Be prepared to defend your motives. Ask yourself: does it make economic sense? Does the promoter check out? When do you pay and when do you get your money back? Does the risk match the rewards? Will it pass the sniff test on audit? What‘s the tax effect of the write-offs in your income bracket? Would you get involved if there were no tax benefits? Don‘t let the year-end tax jitters cloud your judgement. Don‘t become a tax scam victim.
At this time of the year all of us wish we could turn the clock back to January. We should avoid the temptation to try with fake documentation. Big Brother may not be watching, but his computers are. It‘s increasingly more difficult to outwit Uncle Sam. He‘s requiring more cross-reporting between those who give and those who receive. And he has penalties for those who won‘t play the game. This year there will be forms to report more than ever before at State and Federal levels. You’ll be required to report currency transactions involving $10,000 or more, foreclosure purchases, interest, dividends, rent receipts over $600, payments to independent contractors, mortgage interest payments, prizes, rewards, purchases from foreigners. He‘s going to find out who‘s been naughty or nice.
Government at all levels is expanding its control over the citizenry via its new computers. Private real estate transactions are monitored by forcing buyers to disclose the details of transactions – in some instances inter-family transfers – prior to allowing them to record their documents. This information is being shared with various federal agencies along with your income tax returns. Ultimately a government data bank will know the details of both your personal and financial life. Orwell‘s ‘BIG BROTHER‘ was a rank amateur compared to the BIG DADDY that Uncle Sam is turning into. The next step will be Federal Identity Cards which will track all our movements and transactions. That‘s nothing new. We already have them. They‘re called CREDIT CARDS.
Think back on your credit card purchases over the past year. Could the IRS tell anything about your activities by tracing your transactions? What about magazines you read? Conventions/seminars you attend? Bank account balances? They‘ve got it all. And they‘ve bought 20,000 portable computers so their auditors can access your accounts to assess back taxes or to monitor your transactions. They‘re matching information with State and local government and credit agencies too. State lottery winners who owe back taxes, child support, alimony or traffic tickets are having funds withheld to pay them. In like fashion, people with unpaid student loans, defaulted VA and FHA or Federal Land Bank and Farm Home Administration mortgages, Small Business Administration loans will have any tax refunds credited toward their indebtedness rather than receiving it in cash.
But you ain‘t seen nothing yet. With all these computers, it seems just plain troublesome that we should struggle with all those income tax forms when, heck, good old Uncle Sam will compute our income taxes for us just be adding up all those purchases, bank account transactions, real estate transfers, and mandatory reports. Then he‘ll just remove the funds from our bank account – or pay roll, pension plan, or whatever. We‘ll get a receipt from the U.S. Treasury. If we don‘t agree, then we can PROVE it‘s wrong and ask for a refund. After all, how could those friendly folks at the IRS make a mistake? As of now, that‘s not the law but it‘s been proposed by the IRS. Be sure and let your Congressman know how you feel about it. This could be the last year we‘ll have to file.
BE GLAD YOU’RE STILL FILLING OUT TAX FORMS . . .
Under current law we can still make out our tax reports and compute how much we owe. And we can still make some strategic moves if we learn enough. J.K. Lasser‘s 1986 edition of ‘YOUR INCOME TAX‘, available on most newsstands, carries comprehensive lists from pp 325 – pp 332 to help you squeeze your tax returns. It also contains lots of check list pages which should be helpful in organizing your information. It costs $7.95. It can save you much more. You‘ll find it to be quite useful all year long in helping you to understand reporting requirements. There‘s no such thing as knowing too much about taxes! If you want to start a paying hobby, start learning all you can about income taxes.
It’s a good idea to cultivate an avid interest in taxes. They‘re going to be an important part of your life. Here are some publications you might be interested in: That doesn‘t mean that you won‘t need good tax counsel, but it will help you to understand recommended strategies and to be able to contribute toward your accountant‘s remedies.
YOU’VE GOT TO USE MULTI-YEAR STRATEGIES . . .
If you‘re in ‘tax trouble‘ in 1985 it‘s probably because you waited until now to do your tax planning for this year. Here’s what you should do: lay out a spread sheet showing the next two tax years for yourself and for any corporations you own. Show both income and expenses for each year – bearing in mind that a corporation with a fiscal year ending in 1986 will have to be planned for through 1987. Any dividends you‘ll be receiving from that corporation can affect the next calendar tax year for your personal income taxes. On the left hand margin, list all possible sources of taxable income. These might include salaries, sales, rents, commissions, etc. Right after these show any long term capital gains and dividends, interest, etc. from investments. Make the appropriate dollar entry representing these amounts under the year heading in which it will become taxable income. Total each column to show the total taxable ordinary income and long/short capital gains.
Now do the same thing for all of your expenses. If you’ll consult J.K. Lasser’s book previously mentioned, it will help you to avoid forgetting something. When it comes to future year‘s income and expenses, admittedly, you‘ll have to make some guesses. Here‘s how: assume each year will be approximately like this one. Next, apply your best estimate of how your NET income will change by projecting both income and expenses. You might want to use the current consumer price index. If you’ll call (202) 523-1221 you can request to be placed on a monthly CPI Press Release mailing which will give you the current CPI. It’s provided at tax-payer expense. If your income is increased by inflation, increase your estimates by the amount of your projected CPI. If it isn‘t indexed, you can bet your expenses will be, so you might want to decrease it by a factor representing any inflation.
As your figures are projected across the page into the next fiscal or calendar year, keep an eye on what the changes will be made in your tax bracket. If you‘re planning on any sudden increase because of sales or payoff of loans, jumps in interest, new or expanded business, plug these factors in. Be sure to include any deferred maintenance you plan on your properties, vacancy factors, local economic influences. In short, plan your business activities and extrapolate the projected results onto your tax liability. With this done, you should have a reasonable picture of your multi-year income tax bill.
Now the fun begins. The basis of most year end tax strategy is to change the tax year in which you receive income or pay expenses. The problem is, that if you defer income into 1986, the taxes may be higher under a new law. Or you may experience windfall profits not foreseen, so the 1986 tax picture may be much worse for you. Or you might plan to increase expenses in 1985 with the same results. The problem can be reversed too. You might choose to pay more taxes in 1985 in anticipation of a banner year in 1986 only to find the economy slowing and profits plummeting. Then you will have paid too much tax in this year which could have been deferred until 1986. Now you can empathize with big business. They have the same problem, and with the Congress writing new tax law each year, it‘s impossible to predict exactly what your position will be the following year. This is one of the reasons the nation hasn‘t responded to the recovery. Nobody wants to stick his neck out until Congress affirms tax policy under the President’s proposals.
This much we do know: the rules on imputed interest have been set on mortgages carried back by the seller. Except in rare instances 9% stated interest rates will be O.K. on investment SFH. Unstated interest rates will carry the same rate upon audit and the IRS will recompute the sale price so that the agreed upon payments will permit both payment of principal and interest over the same period. For you calculator hackers out there it works like this: suppose I sold you my F&C house for $90,000 with payments of $1000 per month. With nothing down this would be a terrific deal for you. In only 90 months you‘d own the house free and clear IF I were careful to structure zero interest terms. Now enter the IRS during the audit of the seller, they re-calculate as follows: $1000 monthly payment must include 9% interest per annum or .75% per month. And since it also must fully amortize the loan over 90 months, it‘s clear that I must have only gotten. a present value of $65,764.17 for the house. My long term capital gain would be reduced to reflect that value and my IMPUTED interest would be taxed at ordinary rates. On the other hand, you’d be able to DEDUCT IMPUTED INTEREST payments you‘d never made, while your basis for depreciation would have been reduced to the same amount, $65,764.17.
WHAT TO DO ABOUT THE NEW TAX BILL?
We‘ve got a clear indication that real estate will be the whipping boy of the new legislation IF IT EVER GETS ENACTED. We’ve discussed that in past issues. Insofar as last minute strategy is concerned, I think it wise that you should CLOSE anything that you‘d planned to sell in 1986 before the end of 1985. That‘s short notice. This might help speed things up so closings can be in this year. If your state recognizes an installment sale using a Land Contract (which might be called Agreement for Deed, Contract for Deed, Bond for Title, Uniform Sales Contract, etc.), arrange for a quick sale without liability to the buyer and with a minimum down payment. Under the terms of the contract, arrange that the balance of payment be paid in 1986 as soon as all paperwork can be completed. When this has been done, under the terms of the contract which should be drawn to permit it, the buyer can sign a Trust Deed or Mortgage and have fee title transferred to him. Hopefully, this would establish 1985 as the year of sale and of purchase. Each party will gain the benefit of the 1985 rules without having to await the arrival of the financing money which might cause the transaction to close too late in 1986.
1985 transactions should still get the benefit of non-recourse loans, 19 year depreciation, possibly a more benign Alternate Minimum Tax Treatment. If you need income to offset excess depreciation you may have, you have the right to elect to treat the above note as if it had been paid in cash in 1985, thereby removing it from any more dire events falling due in 1986. And your buyers will like the deal better.
If you’re worried about non-deductibility of property taxes and sales taxes, you might be wise NOT TO TRUST YOUR MORTGAGE COMPANY TO MAKE THE PAYMENTS IN 1985. Go pay these taxes yourself in 1985 and get a receipt. (I don’t think there will be any loss of these deductions in the final draft of any bill – the local politicians are fighting the feds over this one.) Where there are state income taxes, the same rule holds true too. 1985 might be a good year to borrow to buy depreciable equipment, make maximum retirement account contributions, buying any cash value life insurance you‘ve been planning on.
IN THE FINAL ANALYSIS . . .
There‘s not much point in getting all worked up over something that may or may not happen in 1986. That‘s an election year. Pols are jockying for power and won‘t want to risk their jobs over a tax bill that everyone seems to hate. If you‘d like a pamphlet explaining the various proposals under consideration, write the JOINT COMMITTEE ON TAXATION Attn: Documents, Washington, DC 20515 ask for Pamphlet JCS-35-84. You’re paying for it!
I’m becoming more and more convinced that Congress will try an end run. In an election year they‘ll want to have done SOMETHING about the deficit and taxes, so they‘ll pass a form of national sales tax or Value Added Tax (VAT). They all like it. It‘s an almost painless way to raise BILLIONS without offending any group – except the citizens. And like I said, most of them won‘t know it or care until it’s too late. . .
