January 1996
Vol 19 No 5
In Florida, at about this time of year, the interstate highways
are crowded with retirees and their RVs. Many of them have
bumper-stickers which say, ‘We’re spending our children’s inheritance’. I
think what they’re really saying is that they intend to consume some of
the fruits of a well-spent life themselves and pass on what’s left to
their children. It’s one thing for those who’ve earned their ‘golden
years’ to spend their own money doing what they want with it. However,
it’s quite another thing for well-paid fat cat bureaucrats to spend
savings that they haven’t earned and which has been wrested from the
public in the form of multiple taxes.
Taxations robs people in two generations.
Those that earn and create surplus capital, and those in the following
generation that stand to inherit it. Payment on the National debt will
deprive future generations of their standard of living more than the
mine, because it will most likely need to be repaid for thousands of
years, if it is to be repaid at all. Figure it out for yourself. We owe
$5 trillion. The President and Congress are arguing over merely
balancing the budget in 7 – 9 years. How long will it be before we can
start to actually pay down the money that we owe? With a budget surplus
of $1 Billion per year, it would take 5000 years to pay back what has
been borrowed thus far.
Bear in mind, that all the rhetoric of the
Clinton administration is not over reduced spending, but over how much
he’s reduced the rate of increasing spending. Even the current budget
battle is over how much more Clinton can add to what we now owe, not
about any reduced borrowing. All the moaning and groaning of government
dependents isn’t about cutbacks or a reduction of the taxed and borrowed
booty they’ll be getting, but rather less than expected increases to
how much they can add to what they’re already spending.
Despite the Contract with America and the
expressed will of the citizenry through their democratically elected
representatives in the Congress, as of this writing, we still don’t have
a new tax bill which would be the first logical step in balancing the
budget. How does a tax cut balance the budget? That’s a point of
contention in Congress. It boils down to whether a higher tax on a
smaller number of income producers would do the job better than a
smaller tax on a larger number of wage earners and businesses.
Some people think the only way to pay for
government largess is through confiscation of a larger portion of a
citizen’s income as soon as possible. They expect to reduce the deficit
and to balance the budget through higher taxes, higher withholding and
higher estimated tax payments. They see the budget as a sort of
sprinkling bucket. Rather than plug any holes, they just want to
increase the water pressure and keep trying to fill it faster.
The other school of thought maintains that
only through economic growth can the Treasury raise enough money to
balance expenditures with income, as well as create a surplus with which
to start reducing our debt. They believe that a tax cut will create
economic growth. They see the budget more as a pie. So long as they can
keep baking bigger and bigger pies, more and more non-paying guests can
pull up to the table without anyone getting a smaller piece. In their
view, lowering taxes increases the size of the pie through growth. They
feel that when people can keep more of what they earn, they work harder.
They produce more taxes collectively while paying fewer taxes
individually.
TO CUT TAXES, YOU’LL HAVE TO LOOK TO YOURSELF . . .
At the risk of having a
retroactive tax bill, which drastically alters the way we pay taxes,
passed in the waning moments of this year; this letter is being sent out
early to give you a little extra time prior to the year’s end to see if
you can’t make some ‘tax-wise’ moves in 1995. Your tax returns are
probably going to be more important in 1995 than in the past few years.
Why? The IRS will have the budget to conduct 450,000 more audits than in
1994. Be sure you stick to the straight and narrow with plenty of back
up data. Audits are going to be much more intrusive than ever before.
With the passage of the Clinton’s 1993 tax
bill, audits took on an entirely new thrust. Even for middle-income
taxpayers, audits have become dangerous. Mere collection of taxes isn’t
all that’s on the agenda. Big brother wants to know how you live. Do you
display a lifestyle inconsistent with reported income? Have any
employees been called independent contractors? Are back payroll taxes
due? For contractors deemed to have been employees, were any OSHA
work-place guidelines ignored? Have the deemed employees been deprived
of a chance to participate in the employer’s retirement plan?
Where taxes are discovered to have been
unpaid, is it possible there was a conspiracy to under-report taxes
between taxpayers, bookkeepers and accountants? Would RICO penalties
apply? Consequently, could assets be seized out of hand? Avoiding an
audit is certainly the first line of defense in devising tax strategies,
but understanding and using the tax laws to your advantage is
fundamental in being able to keep more of what you’ve earned.
Clearly, now is the time for taxpayers to
straighten up and fly right, but that doesn’t mean you should pay more
than the law says you must. Taking an interest in your own tax
strategies and preparation will pay you more with the passage of each
year. Keeping up with the changing tax playing field is what makes long
and short term tax planning so difficult. Anticipating what’s coming up
and planning accordingly is vital. The Kiplinger Tax Letter, (800)
544-0155, does a good job in keeping abreast of upcoming tax change
proposals.
If you can operate a computer, this isn’t
going to be as painful as you think, it can almost be fun. ‘Quicken’ is
an inexpensive, top-rated bookkeeping program for small businesses. On
your computer you ‘write’ deposit slips and checks. These are
automatically posted to computer ‘books’ that you set up. Any time you
want them, the computer will print out reports, graphs, trend charts,
etc. It will do something which is even more exciting. It will send all
the information it has compiled over to another computer program for
preparation of your income taxes.
‘TurboTax’ is a program which accepts all
of the information that’s already been entered over the year into
‘Quicken’. With the push of a button, it will do your tax return,
printing out the various IRS forms and schedules and self-checking
itself to make sure it’s correct. It will even let you play ‘what if’
with various decisions you might want to make as to how to treat various
items of income and expense. When you’re all through, it will review
the form and tell you which entries you’ve made that may create a higher
audit profile.
Computerized tax returns can provide a
solid foundation for forming complex, multi-year strategies. Your tax
professional will find the returns they generate to be a lot easier to
work with than a shoe-box full of receipts and cancelled checks.
Moreover, he or she will have more confidence in your computer-generated
returns and be able to work with you more effectively. Being able to
communicate your tax problems better and to understand the advice given
will improve your after-tax income level overall.
YEAR-END TAX STRATEGIES ARE NECESSARILY LIMITED
For people, most partnerships, S-corporations, LLCs and Trusts, the tax year ends on December 31st
each year. For most C-corporations it can pretty much end where it
makes the most sense for the conduct of the business. For example, if
your customers settle up their accounts by writing checks or using VISA,
Discover, American Express, or Master Card the last day of the month;
it’s easy to see that you wouldn’t receive them until a few days later.
Thus, if these were written on December 31st, 1995; even
though the customer would be able to deduct the expenses in 1995, you
wouldn’t actually be able to spend the money until 1996. Therefore, you
could elect a fiscal year for your corporation that ended on January 31st and defer taxes if you wanted to.
One of your year end strategies might be to
incorporate rather than to operate as one of the other types of
businesses. This way some of your taxes could be received in a different
fiscal year. This could provide some other benefits as well. Because a
corporation is usually taxed in the State where it is formed, it might
avoid income tax levels at the State level in places like Nevada,
Delaware, Washington, South Dakota and Wyoming where there is no State
tax at the corporate level. If, like many profitable businesses today,
it did a lot of business by mail, telephone, computer or FAX; a
significant tax savings might materialize because profits received in
the low taxed state wouldn’t be taxed as highly as those received where
you reside.
Of course other tax savings would realized because corporations as a rule enjoy lower tax brackets than individuals. Having some earnings taxed at the corporate level, a portion of which, wages are paid to you personally, also divides the income in such a way that both the corporation and you might wind up with a lower tax bracket. And let’s not forget corporate deductions. When property is owned by a corporation, it is deemed to be owned for business purposes. Up to $17,500 can be expensed for personal property used in trade or business and deducted from taxable corporate profits. A whole raft of other deductions is available in the form of employee fringe benefits. In so many words, these benefits amount to tax-free compensation to employees.
Let’s see. We’ve mentioned writing expense checks and using credit cards on the last day of the year in order to get last minute write-offs. These could be used to pay property taxes, insurance, maintenance, employee bonuses, wages and salaries, utility bills, and to buy equipment which could be expensed. If you don’t have enough money to pay these expenses, use your credit cards, vendor credit, or borrow your deductions from the bank. How does this make sense?
If you were in the 28% marginal tax bracket, you’d be able to deduct 100 cents out of every dollar you spent from your taxable income. That would reduce your tax bill by 28 cents. Another way of saying this is that, everything you spent in 1995 would only cost you 72%. If the cost of credit was to be 1% per month and you repaid your loans out of January’s income, you’d be spending 1% to save 28%. That’s not too shabby.
Want to have your cake and eat it too? Start up an IRA, Keough, K-401, etc. retirement plan and have your own company borrow to contribute to it. You’ll be able to deduct expenses and interest at the company level, and store up the money tax free at the personal level. Let’s talk house deals.
Suppose the President springs a surprise on us and signs the new tax bill which contains a provision for reduced capital gains taxes, you can close quickly by selling on an installment sale contract with only a token down payment, say $10, and electing out of installment reporting on the entire contract. As early as possible in 1996, after permanent financing has been obtained, the contract can be paid off in full. You’ll have moved the sale back into 1995 for tax purposes where gain might be offset by losses taken previously which might not be allowed in 1996. Of course, you can take the opposite tack by using the same contract to hold a willing buyer, but to delay the closing until after 1996 in the event no tax bill is signed. This will move the taxable event into 1996 where, hopefully, the tax bill will be signed.
TAX CHANGES ARE DEFINITELY ON THE HORIZON . . .
The tax bill that was passed by Congress in November, but not yet signed, included a lot of special health-related features. Deductions for all kinds of medical care and insurance would be increased. $2000-$4000 could be set aside tax-free in a Medical Savings Account (MSA) to supplement the costs of catastrophic health insurance. Retirement plan funds could be withdrawn without penalty to pay for medical bills. Insurance policies could be cashed in tax free by the terminally ill to pay for hospital expenses.
What about real estate? Under the bill, you’d be able to deduct losses on sale of personal residences. Great for California houses. Tax-free residence replacements could occur as often as possible without waiting for 2 years, but depreciation would be recaptured. $125,000 exemption would be reduced if a residence was used for business and depreciated then later sold as a residence. $125,000 exemption could still be used on sale of an over-55 year old’s principal residence even if he or she married someone who’d previously used it. Prior to passage of the bill, it would have been lost.
There’s good news for government and civilian retirees who have moved from a former high taxed State, but who are still being dunned for income tax on their pensions. Both the Senate and House have bills pending which prohibit taxing all or part of pensions of former residents. Both Florida and Nevada will be major beneficiaries of this when passed as millions of well-heeled retirees stream over the border. Not law yet, but passage looks good.
In a recent study that I read, a spouse’s estate was reduced by 74% by a combination of income, estate and excise taxes. We continue to rob widows and orphans to support government waste. California Republican Congressman Chris Cox has introduced the 1995 Family Heritage Preservation Act to repeal Federal Estate and Gift taxes as well as the Generation Skipping Tax. About all these taxes do is to bring otherwise solvent families into poverty while providing less than 1% of Federal revenues. These are clearly an envy-based.
On the other hand, the damage done by robbing capital formation through these taxes is awesome. If the act had been passed in 1993, it is estimated that the Gross Domestic Product would have grown by $79,220,000,000 creating 228,000 new jobs while increasing savings by $639,000,000,000. You can register your support for this bill by writing The Honorable Roger Zion, 60/Plus, P.O. Box 96512, Washington, DC 20090-6512. Unless we leave some of the money in private hands, there won’t be anyone left but government dependents, and nobody to pay taxes.
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