From Today’s WSJ: States Slammed by Tax Shortfalls
The stumbling U.S. economy is forcing states to slash spending and cut jobs in order to close a projected $40 billion shortfall in the current fiscal year.
…Unlike the federal government, most states are required to balance their budgets. Most have so far resisted tax increases, instead opting for raising prices on things like tolls and college tuition, and cutting back on services like education and health care. Some chose one-time measures such as tapping rainy-day funds that were built up in flusher times.
The housing slump, now well into its second year, is the primary culprit. The decline in home sales has cut into real-estate transfer taxes. Construction spending and employment has declined. Fewer home sales have resulted in lower sales of home furnishings and washing machines, eating into sales taxes.
Of course, for many states, today’s budget woes stem at least partly from expanding their services during good times and not planning enough for the inevitable downturn.
Ahh! The last sentence is only partly true: I would say that at least 95% of the state’ budget woes stem from expanding government too much in the good times of the past few years. This is cold and cynical but here’s my analysis of the current situation:
Many states (New York, New Jersey, California, Maryland, Massachussets all come to mind) have horribly irresponsible governments. These states are run by liberals who use any chance they get to increase the size and scope of the state government. They got their chance too: all of these states participated in the housing bubble. This created a temporary surge in tax revenues. These states increased services and made promises with the expectation that the good times would last forever. Anybody with half a brain (much more than anyone in the New York State Senate has) could have seen that this was a bubble and was not going to end well.
Now that the shit is hitting the fan and the bubble is busting, legislatures in these states are acting like their problems were inevitable. The irony is, if these states raise taxes and fees, they will further encourage the people who live there to get out and move to more responsible states where taxes are lower.
The tendancy of democratically elected governments to overspend (and over-promise) in the good times is a key reason why inflation/debasing of the currency is a virtual guarantee.
The annual Berkshire Hathaway (BRK) meeting, complete with the usual Buffett-worship, is going on now in Omaha, Nebraska. As fascinating to me as Buffett’s investment success and methodology, is his tax savvy. It’s been said that Buffett “plays the tax code like a fiddle” and that he “knew more about tax law than any lawyer in the country.”
The best example is how Buffett has compounded his retained earnings by not paying out any dividends to shareholders. As with all “C-Corps”, Berkshire Hathaway pays tax at the corporate level. Then, when dividends are distributed to shareholders, the shareholders pay tax individually. This amounts to double taxation and is the reason why many people structure their businesses as flow-through entities like LLC’s and S-Corporations.
But Berkshire has never paid a dividend to shareholders – instead, Buffett has reinvested all earnings in the business. Here’s how this worked out for Buffett in 2007:
In 2007, Berkshire Hathaway earned a profit of $13.213 billion. If the company paid out dividends at the same rate as General Electric – 50% – Buffett would have personally received a dividend check of $1.86 billion. His tax rate on these earnings would be approximately 21% (15% Federal and 7% Nebraska), thus Buffett would have paid a whopping $390 million in federal and state taxes! So, by not issuing a dividend, Buffett saved himself $400 million this year. The compounded effect of not paying dividends has added many, many billions to Buffett’s net worth. Pretty smart.
Your Federal and State taxes must be paid throughout the year on a “pay as you go” basis. For employees – people who receive a W2 – taxes are withheld from each paycheck. For self employed people, or people who have income in addition to earned income, quarterly estimated taxes are required.
How to Calculate Estimated Tax:
The best way to calculate your estimated tax payments – for both federal and state – is to prepare a projected 2008 tax return. Each quarter you should estimate what your full-year 2008 income will be and calculate the tax you will owe based on this amount.
For example, let’s say you received $100,000 of income in Q1 on which zero taxes were withheld. Let’s also assume that you don’t know what you will receive in the next three quarters – could be more, could be less. Project your 2008 income by annualizing the amount you earned in Q1. In this example, you would project your 2008 earnings to be $400,000. Calculate the federal and state tax you would owe based on this projection. Pay ¼ of this amount by April 15, 2008. Do this each quarter and “true-up” your payments so that you are on track to pay 100% of your tax liability by January 15th, 2009.
2008 Estimated Tax Payment Due Dates:
Q1: April 15, 2008
Q2: June 16, 2008
Q3: September 15, 2008
Q4: January 15, 2009
How to Make your Quarterly Estimated Payments Online:
Enroll in the Electronic Federal Tax Payment System – EFTPS. Each quarter when you determine your tax liability, login to the site to make a payment. Alternatively, write a check and mail form 1040-ES each quarter.
New York State:
Go to the New York State Online Tax Center Website: http://www.tax.state.ny.us/nyshome/online.htm and register. Each quarter when you determine your tax liability, login to the site and make a payment.
Here is an overview of the filing requirements for New York City S Corporations:
The S Corporation must file Form 1120S by March 15th of the year following the year covered in the return (unless the corporation operates on a fiscal year other than calendar year). Form 1120S also includes Schedule K1 , which lists each shareholders’ share of income and losses. Schedule K1 is provided to the IRS, and to the shareholder.
** Since the S Corporation is a flow-through entity, the corporation itself pays no Federal income tax. Thus, the 1120S is an “information-only” return — all items of profit and loss are flowed through to the shareholders’ individual income tax returns.
New York State
For a New York State S Corporation, you must file Form CT-3-S by March 15th. S Corporations must pay a franchise tax which is based on size of payrolls.
New York City
New York City does not recognize S corporation status, even though New York State and the IRS do. Instead, the net income of an S Corporation is taxed as if it were a C Corp at a flat rate of 8.85%. The minimum tax is $300.
** What makes this tax particularly obnoxious is that as a New York City resident, you receive no deduction for the tax paid by your S-Corporation.**
Follow the link for a great article by Richard Bahn of the Cato Institute called “Inflation and the Tax Man”
The fact that capital gains are not indexed for inflation has always irritated me. Now that Rudi Giuliani (who I’m not necessarily in favor of) has made this part of his tax proposals, the idea has gotten a lot more press. Here’s an excerpt from the article:
Assume you purchased a common stock in a company in 1984 for $100 a share and sold it in 2007 for $200 a share. Have you received any “income” from the sale of the shares of stock? The IRS would say “yes,” but this is clearly wrong. The IRS will claim that you had a $100 per share capital gain on the stock in the above example, yet actually the increase was solely a result of inflation. Because you cannot buy more goods and services with $200 now than you could have with $100 in 1984, you have had no “income” or wealth accretion.
The debate centers on the definition of income. The 16th Amendment to the Constitution states, “The Congress shall have the power to lay and collect taxes on incomes,” and the Fifth Amendment clearly states, “No person shall . . . be deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use without just compensation.”
If the portion of a capital gain due solely to inflation is not income, then taxation without inflation-indexing is an unconstitutional taking of property. Income is commonly defined as, “the amount of money or its equivalent received during a period of time in exchange for labor or services from the sale of goods or property, or as profit from financial investments.”
It is not likely that many judges or members of Congress would find it in their personal, political, or the national interest to argue that phantom gains are “income.” After all, most Americans do understand the meaning of income, even if some in Washington do not.
This would make for an interesting Supreme Court case. Chances are, the only way the IRS would find out you were indexing your capital gains for inflation is if you told them in a note on your return. I could be mistaken but I don’t think Schedule D audits are very common… after a few years, nobody has any idea what their basis is in anything.
Situation: A client of mine will be starting business school part-time this fall. His employer will not be reimbursing his tuition expenses of $30,000 per year.
Question: Can he deduct the full amount of this expense on his Schedule A? Forget about the Hope & Lifetime Learning credits for now. We want to know if he can deduct the full amount of the tuition as an itemized deduction.
Answer: The short answer is that I believe my friend should go ahead and take the full deduction. There is no guarantee the IRS will allow it but a recent court decision is very encouraging. Read on for more details.
Section 162 of the Internal Revenue Code allows individuals a deduction for un-reimbursed business-related expenses. (The deduction is allowed only to the extent these and other miscellaneous items exceed 2% of the taxpayer’s AGI.)
In certain cases, job-related education expenses may be considered a business-related expense (Section 1.162-5). To qualify, the coursework needs to meet either of these two tests:
1. The classes must maintain or improve the skills needed to perform current job function.
2. The education is required by your employer or the law to keep your present salary, status or job.
However, if the coursework meets either of the next two tests, it is not qualifying work-related education, and thus not deductible:
1. The education is required to meet the minimum education requirement of a profession
2. The education will qualify you to perform a new trade or business
Because of these rules you can’t deduct your tuition for college, med school, or law school. Attending med school is a minimum requirement to become a doctor. Furthermore, graduating med school qualifies you to perform a new trade or business: being a doctor.
But what about business school? Generally speaking, an MBA does not qualify you to do any particular job. Moreover, it is not a truly a requirement for any profession that you have an MBA.
Until very recently however, the IRS did not agree with that assessment. In McEuen et. ux. v. Commissioner, the Court found that the MBA was indeed a requirement for the taxpayer’s industry (investment banking) and that the MBA qualified the taxpayer for a new trade or business (to be a full-fledged investment banker, as opposed to her previous title: Financial Analyst).
Earlier this year, however, in D.R. Allemeier v Commissioner, the Court ruled that the taxpayer, Daniel Allemeier, was allowed to deduct the full amount of his MBA tuition. The reason: his job responsibilities did not directly change as a result of the MBA.
Here is an excerpt from the Court opinion which addresses the rules listed above (Note: Respondent=IRS, Petitioner=taxpayer Daniel Allemeier):
Rule: MBA is not deductible if it is a requirement of his employment with the company
Court: We must determine, therefore, whether Selane products conditioned promotions, rather than employment generally, on petitioner beginning the MBA program. The record does not support respondent’s contention, however, that petitioner’s promotions were contingent on his beginning the MBA program. Encouraging petitioner to obtain MBA and speculating that he might advance faster with the MBA is not tantamount to a requirement that petitioner obtain the MBA. Moreover, we decline to find that a minimum education requirement existed merely because petitioner’s promotions happened to coincide with his enrollment in the MBA program.
Rule: MBA Does the MBA qualify the taxpayer to perform a new trade or business?
Court: We must next determine whether petitioner’s MBA qualified him to perform a trade or business that he was unqualified to perform before he earned the MBA. The Court has repeatedly disallowed education expenses where the education qualifies the taxpayer to perform “significantly” different tasks and activities.
Respondent claims that petitioner’s evolving duties and promotions after he enrolled in the MBA program demonstrate that petitioner was qualified for and indeed entered a new trade or business at Selane Products once he began the MBA program. In sum, respondent argues that the MBA qualified petitioner for the specific new trade or business of “advanced marketing and finance management.”
Petitioner disagrees and argues that the MBA enhanced and maintained skills he already used in his job, but did not qualify him for a new trade or business or for any particular promotions. Petitioner argues that the MBA merely capitalized on his abilities that he had before beginning the program, giving him a better understanding of financials, costs analyses, marketing, and advertising. After careful consideration, we agree with petitioner.
Accordingly, we find that petitioner’s MBA did not meet a minimum education requirement of Selane Products. Nor do we find that the MBA qualified petitioner to perform a new trade or business. Petitioner may deduct the amount of MBA tuition expenses.
Using this interpretation as precedent, it seems that MBA tuition will be allowed for many (if not most) people. It is highly dependent on individual “facts and circumstances” – the two most important being:
1. Did the MBA lead to a job in an entirely new field – one for which you would have been unqualified before earning the MBA?
2. Is obtaining the MBA a requirement of the job?
In other words, with careful planning and great documentation, the full amount of an MBA – which could be as much as $80,000 – can be written off. Great news!!
Whatever you do, don’t take this as specific advice. This post is meant as a starting point for further research and planning only.
Daniel R. Allemeier, Petitioner v. Commissioner of Internal Revenue
United States Tax Court T.C. Summary Opinion
McEuen, Petitioner v. Commissioner of Internal Revenue
United States Tax Court T.C. Summary Opinion
Is An MBA Deductible?
Wandering Tax Pro
Tax Court Ruling Allows Deduction on MBA Degree
Wall Street Journal
Writing Off an MBA