President Obama recently released his 2015 budget proposal and included revisions to the tax laws that, in some instances, changes laws that have been on the books for sixty years. Keep in mind these changes are currently only proposals; however, they do provide insight into the administration’s planning and intentions to implement new taxes and reduce benefits we currently receive under the tax code.
Below are short summaries of some selected proposals we are reviewing, which if they become law, will be effective beginning Jan 1, 2015.
1. Repeal LIFO method of accounting
President Obama is proposing to repeal the use of the Last In First Out (a/k/a “LIFO”) inventory accounting method for Federal income tax purposes. Some taxpayers benefit by using LIFO to pay less taxes on recently added inventory that is more expenses than previously purchased inventory.
Taxpayers currently using the LIFO method would be required to change their method of inventory accounting to include in income their prior-years’ LIFO inventory reserves (the amount of income deferred under the LIFO method). The adjustment is a one-time increase in gross income that can be spread over ten years, beginning with the year of change.
What taxpayers are affected? Businesses purchasing inventory with continuous price fluctuations.
The current administration intends to eliminate a tax deferral opportunity available to taxpayers that hold inventories, which increase over time. The revisions may also eliminate a complex and burdensome accounting method that has been a point of contention between the IRS and businesses.
2. Implement a new “Fair Share Tax”
The proposal would impose a new minimum tax, called the Fair Share Tax (FST), on high-income taxpayers. The FST will be calculated by applying 30 percent of your Adjusted Gross Income (“AGI”) less a credit for charitable contributions.
The final FST amount will be calculated by the amount the FST exceeds the sum of the taxpayer’s:
- regular income tax (after certain credits) including the 3.8-percent net investment income tax,
- the alternative minimum tax (“AMT”), and
- the employee portion of payroll taxes.
According to the U.S. Treasury’s interpretation of Obama’s 2015 budget proposal, this proposal is aimed at eliminating methods used by high-income taxpayers to reduce their tax liability – i.e. by using deductions or by deriving large benefits from low tax rates on dividends and capital gains. For instance, nearly 90 percent of families in the top 0.1 percent of the income distribution benefit from the lower tax rate on dividends and capital gains, compared to less than 10 percent of families in the bottom 60 percent of the income distribution. Moreover, the maximum 23.8 percent tax rate on dividends and capital gains is well below the statutory tax rates on wages incurred by lower income families.
3. Requires any business paying contractors $600 or more to receive and verify the contractor’s Taxpayer Identification Number (TIN) and withhold taxes
The proposal will require a contractor receiving payments of $600 or more in a calendar year to give the business the contractor’s certified Taxpayer Identification Number (“TIN”). A business would be required to verify the contractor’s TIN with the IRS, similarly to how companies are currently required to verify an employee’s TIN (by matching the social security number to the employee’s name).
If a contractor fails to furnish an accurate certified TIN, the business (receiving the services and making a payment to the contractor) will then be required to withhold a flat-rate percentage of gross payments.
As with other areas of the tax code, any individual required to withhold taxes (a/k/a a “withholding agent”) is generally liable if taxes are not withheld.
4. Revise the Offer in Compromise rules to eliminate the non-refundable payment
An Offer in Compromise (“OIC”) allows you to settle your tax debt for less than the full amount you owe. It may be a legitimate option if you can’t full pay you tax liability within the 10 year collection period, or if doing so creates a financial hardship. The IRS considers various factors in determining whether a taxpayer qualifies for an OIC: your ability to pay; current and future income; necessary and ordinary living expenses (or recurring expenses for businesses); and the amount of equity remaining in your assets (i.e. your home, cars, etc.).
Currently, taxpayers making a lump-sum offer-in-compromise must include a nonrefundable payment of 20 percent of the lump-sum with the initial offer. In the case of an offer-in-compromise involving periodic payments, the initial offer must be accompanied by a nonrefundable payment of the first installment that would be due if the offer were accepted.
For instance, if you are offering $50,000 to settle a $200,000 tax liability with the IRS, and you elect to make a lump-sum payment, the IRS requires you to submit a 20% payment (here $10,000) along with your offer for the IRS to even consider the offer. If the OIC is rejected, the government keeps your non-refundable payment but applies the payment to your existing tax balance.
This proposal would eliminate the requirements that an initial offer-in-compromise include a nonrefundable payment of any portion of the taxpayer’s offer. Thus, taxpayers would then be able to submit an offer without any payments or risk of loss should the offer be denied. The downside to the government is that taxpayers can submit unsupported offers for unreasonably low amounts that are not in good faith.
While an OIC is being reviewed by the IRS, the IRS generally places a hold on collection activity for the years covered by the offer. The taxpayer who submits a good faith offer intending to resolve his or her tax debts would be required to wait approximately six to nine months until the IRS concludes its investigation and makes a determination.
Therefore, we should expect to see additional modifications to prevent abuse, should this proposal become law.
5. Make it a felony to “willfuly” fail to file a tax return any 3 of 5 consecutive years
The proposal would provide that any person who willfully fails to file tax returns in any three years within any five consecutive year period, if the aggregated tax liability for such period is at least $50,000, would be subject to a new aggravated failure to file criminal penalty.
The proposal would classify such failure as a felony and, upon conviction, impose a fine of not more than $250,000 ($500,000 in the case of a corporation) or imprisonment for not more than five years, or both.
Currently, a willful failure to file a tax return is a misdemeanor punishable by imprisonment of not more than a year, a fine of not more than $25,000 ($100,00 for corporations), or both.
The tax laws currently define willful as, “The voluntary, intentional violation of a known legal duty.” Mere understatement of income and the filing of an incorrect return may not in itself constitute a willful attempt to evade tax. Absent an admission or confession, willfulness is rarely subject to direct proof and generally must be inferred from the facts and circumstances. Willfulness may be inferred from any conduct, the likely effect of which would be to mislead or conceal, such as that exemplified in Spies.
If you have further questions about President Obama’s 2015 tax proposals, please contact the Law Milikowsky Tax Law.