Florida Tax Attorney Blog

In its January 2011 report, the Congressional Budget Office (CBO) estimated that America's expanding spending policy will generate a combined deficit of nearly $8.5 trillion over the ten-year period from 2011 to 2021. Significantly, 30% of this projected overspending ($2.5 trillion) will be incurred in 2011 and 2012 alone. These projections are in spite of the CBO's warning last year that, "[t]o keep federal deficits and debt from reaching levels that would substantially harm the economy, lawmakers would have to significantly increase revenues, decrease projected spending, or enact some combination of the two." In light of this cautionary apprisal, a European-style value added tax (VAT) has emerged as a potential solution. Indeed, just this week, Jeffrey Owens, a director of the Organization for Economic Cooperation and Development (OECD), called for international agreement on a VAT structure at a lecture at NYU's School of Law.

Components of a good tax. There are four components of a good tax:

1. a tax should be fair and equitable;
2. a tax should be transparent;
3. the time and manner of tax collection should be convenient for the taxpayer; and
4. tax administration should be efficient.

With that being said, while it is true that the United States is the only major nation without a VAT, it does not necessarily follow that VAT is an appropriate or even viable solution for the United States. To the contrary, a U.S. VAT would be inequitable, hidden, inconvenient, and inefficient.

A U.S. VAT would be inequitable. A tax is considered to be equitable if citizens pay tax in proportion to their respective abilities. Under American tax policy, a taxpayer's ability to pay is measured in terms of available revenue for spending. In this regard, a U.S. VAT would be inconsistent with the ability to pay principle insofar as it measures taxpayers' ability to pay in terms of consumption rather than available revenue. In addition, a U.S. VAT would be inequitable in the sense that taxpayers would bear dissimilar tax burdens. A fair tax requires equal sacrifice from all taxpayers, but the incidence of a U.S. VAT would fall primarily upon lower income taxpayers because lower income taxpayers will spend higher percentages of their incomes on VAT.

A U.S. VAT would lack transparency. A value-added tax is a hidden form of taxation because those who ultimately pay it - i.e. consumers - are unaware of what they are paying. The hidden nature of a U.S. VAT would be particularly problematic because hidden taxes are easily increased by the government with little taxpayer resistance. Accordingly, once a value-added tax is introduced into the U.S. Tax Code, the rate of taxation is almost certain to increase. Indeed, there is a historical correlation between increased revenue and increased spending in the United States.

Continue reading "MORE MONEY, MORE PROBLEMS: A VALUE-ADDED TAX IS NOT THE ANSWER FOR THE U.S. " »

A bond swap is a tax and investment strategy whereby an investor sells a bond that has declined in value and simultaneously purchases a substantially similar bond with the proceeds from the sale.

Why?

If an investor plans to use the proceeds of the bond sale to purchase a substantially similar bond, why not just hold the existing bond? The reason is purely strategic. By engaging in this type of transaction, the investor generates a tax loss. This artificially generated tax loss can be used to offset capital gains and ordinary income without altering the general composition of the taxpayer's investment portfolio.

Here's How It Works:

Step 1: investor sells a bond that has declined in value.

Step 2: investor simultaneously purchases a bond with substantially similar attributes in terms of principal amount, yield, and recovery period.

Following this transaction, the investor continues to own a bond with substantially similar investment characteristics and also holds a tax loss that can be used to reduce his or her income tax liability. The tax loss realized on this transaction can be used to offset capital gains realized on other investments. In addition, to the extent the loss exceeds capital gains, it can be used to offset up to $3,000 of ordinary income. SeeInternal Revenue Code §1211(b). Any loss beyond that can be carried forward and used to offset capital gains and ordinary income in future tax years. SeeInternal Revenue Code §1212(b).

IRS May Challenge Bond Swap Transactions Under 2010 Legislation.

Investors have been engaging in bond swap transactions for years in order to trigger tax losses without altering their overall economic positions, and this practice has generally been accepted by the IRS. Moreover, the United States Supreme Court has seemingly endorsed this tactic. See Cottage Savings Association v. Commissioner (upholding mortgage loan swaps by banks to realize tax losses). But recent additions to the Internal Revenue Code have raised questions about the continued propriety of this tax and investment strategy.

In 2010, Congress codified the common law economic substance doctrine in Section 7701(o) of the Internal Revenue Code. Under the economic substance doctrine, tax benefits are denied if the transactions giving rise to the benefits lack economic substance apart from tax considerations. Pursuant to Section 7701(o)(1), in cases where the economic substance doctrine is relevant, a transaction shall be treated as having "economic substance" only if: (1) the transaction meaningfully changes the taxpayer's non-tax economic position; and (2) the taxpayer has a substantial non-tax purpose for entering into the transaction.

Because the bonds swapped are substantially similar and because the sole purpose of a bond swap is to create tax losses without changing the investor's overall financial position, this type of transaction is subject to challenge under this new legislation.

Bond Swaps Probably Remain Acceptable Despite 2010 Legislation.

Notwithstanding the 2010 codification of the economic substance doctrine, bond swaps probably remain safe tax and investment strategies.

First, in order for the IRS to invoke Section 7701(o) to challenge a bond swap transaction, the statute requires that the economic substance doctrine be "relevant" to the challenged transaction. Based on the pertinent case law, the economic substance doctrine is arguably irrelevant to a bond swap transaction. Indeed, in Cottage Savings, the Internal Revenue Service raised the economic substance doctrine in opposition to a bank's mortgage swap transaction, but the Supreme Court declined to apply the doctrine. Moreover, the Supreme Court seemingly rejected the relevance of the economic substance doctrine in swap transactions when it stated that, "a much less demanding and less complex test" is required.

Additionally, even if the economic substance doctrine is relevant to bond swap transactions, this type of transaction arguably possesses economic substance and business purpose apart from tax considerations in the sense that, although similar, the two debt instruments differ in the sense that they represent different debt obligations and have different issuers. Moreover, swap transactions have substance beyond the tax considerations in the sense that the swap itself is a mere component of a larger transaction of deriving a desired rate of return on the overall investment portfolio.

Continue reading "BOND SWAPS MAY BE SUBJECT TO CHALLENGE UNDER NEW TAX LAW" »

Under Subchapter S of the Internal Revenue Code, qualifying corporations can elect S corporation status, which allows the corporation to be treated as a flow-through entity for income tax purposes. This means that the income, deductions, and other tax attributes of the corporation flow through to the shareholders, who report corporate earnings on their individual tax returns. While this may seem insignificant, self-employed individuals can realize huge tax savings by operating as an S corporation.

Here's how it works:

The earnings of an S corporation can be allocated to shareholders in one of two ways: (1) as salary; or (2) as a distribution of profit.
Significantly, any amounts in excess of salary (i.e. distributions of profit) are not subject to FICA (Social Security) or Medicare taxes.

Therefore, self-employed individuals can partially opt out of the 12.4% FICA (Social Security) tax (on first $106,800 of salary) and the 2.9% Medicare tax to the extent that earnings are classified as a distribution of profit (rather than as salary).

As an example, consider a personal trainer who opens a personal training studio. Let's say that after paying all expenses, our trainer earns $100,000 during 2011. If the entire $100,000 is paid out as salary, the trainer will pay $15,300 in payroll taxes. ($12,400 FICA (Social Security) tax; $2,900 Medicare tax).

If, instead, $53,323, which is the average salary for a certified personal trainer according to the American Council of Exercise, is classified as salary and the remaining $46,677 is classified as a distribution of profit, the trainer will pay $8,158 in payroll taxes ($6612 FICA (Social Security); $1,546 Medicare). This amounts to payroll tax savings of $7,142, or 46.6%!

This loophole is popularly referred to as the "Edwards gambit," named after American attorney and politician, John Edwards, who notoriously avoided more than $500,000 in Medicare tax by employing the Subchapter S corporate structure for his law firm. In the four years before becoming a U.S. Senator, Edwards earned some $27 million as a personal injury lawyer. Of this $27 million, he classified about $1.5 million as salary and the remaining $25.5 million or so as a distribution of profit. In this way, he avoided paying Medicare tax on more than $25.5 million of earnings and saved $591,112.

To be sure, Edwards' tax avoidance tactic was widely criticized by political adversaries as evasive and deceptive. But the fact is that this tax avoidance strategy, when employed in a reasonable and non-abusive manner, remains permissible under the current tax law. So, don't hate the player, hate the game.

Continue reading "S CORPORATION COULD MEAN HUGE TAX SAVINGS FOR SELF-EMPLOYED INDIVIDUALS" »

In the wake of the recent congressional debt-reduction deal, there has been a lot of talk about a luxury tax as a means of generating additional revenue. But with the yachting industry based primarily out of South Florida, a luxury tax would be detrimental to Florida's already ailing economy.

Proponents of a luxury tax argue that if taxes must be increased, it should be in the form of a luxury tax because a luxury tax would target the wealthy (who, according to them, should pay more taxes than less wealthy Americans who receive the same government services). Proponents further tout the "fairness" of a luxury tax, contending that taxpayers can avoid a luxury tax by abstaining from the purchase and consumption of luxury items, such as yachts, jets, and expensive automobiles.

But "fairness" was the cornerstone of the luxury tax enacted in 1991 under the Bush Administration. Proponents of that tax contended that the 10% tax on luxury items was a proficient means of raising revenue insofar as wealthy Americans who purchase luxury items would bear the tax without financially affecting lower- and middle-class Americans.

But while the Bush Administration might have had noble intentions, the practical effect of the luxury tax of the early 1990s was to destroy jobs, spike unemployment, and dismantle the previously well-established American shipbuilding industry.

Indeed, Viking Yachts, which was the largest American shipbuilder at that time, was forced to fire more than 81% of its workforce and discontinue production operations at one of its two U.S. manufacturing facilities within eight months of the luxury tax taking effect. In addition, more than 33% of American-based yacht building companies abated production altogether during the first year of Bush's luxury tax regime.

Continue reading "LUXURY TAX WOULD DESTROY SOUTH FLORIDA YACHTING INDUSTRY" »

One of the IRS's most commonly invoked arguments in the corporate context is the economic substance doctrine. Under this doctrine, tax benefits are denied if the transactions giving rise to the claimed tax benefits lack "economic substance" apart from tax considerations.

Of course, this begs the question: when does a transaction with favorable tax consequences have "economic substance" apart from the tax benefits?

As every good tax attorney knows, the answer is always a resounding, "it depends."

Over the years, different courts have formulated varying approaches for evaluating the economic substance (or lack thereof) of a transaction. Some courts have adopted a two-prong test requiring corporate taxpayers to establish: (1) economic substance; and (2) a business purpose. See e.g., Pasternak v. Commissioner, 990 F.2d 893, 898 (6th Cir. 1993). Other courts have adopted a disjunctive approach requiring corporate taxpayers to establish either: (1) economic substance; or (2) a business purpose. See e.g., Black & Decker Corp. v. U.S., 436 F.3d 431 (4th Cir. 2006). Still, other courts have considered all relevant factors in evaluating questionable transactions, with economic substance and business purpose constituting non-determinative factors to be considered. See e.g., ACM Partnership v. Commissioner, 157 F.3d 231 (3d. Cir. 1998); Sacks v. Commissioner, 69 F.3d. 982, 985 (9th Cir. 1995).

In an effort to clarify the law on this point, Congress added Section 7701(o) to the Internal Revenue Code last year. Pursuant to Section 7701(o)(1), a transaction has "economic substance" if: (1) it changes the taxpayer's economic position in a meaningful way (apart from Federal income tax effects); and (2) the taxpayer has a substantial non-tax purpose for entering into the transaction.

Still, this begs the question: what types of non-tax benefits must a corporate taxpayer establish to demonstrate a "meaningful" non-tax change in economic position and what type of purpose must a corporate taxpayer have to establish a "substantial" non-tax purpose?

Continue reading "TECHINCAL COMPLIANCE WITH THE TAX CODE MAY BE INSUFFICIENT IN THE CORPORATE CONTEXT" »

This past Labor Day weekend, I married my college sweetheart (go Canes!) in Vero Beach, Florida!

My husband's parents kicked off the weekend with an exquisite rehearsal dinner at the Vero Beach Hotel & Spa. On Saturday afternoon, we married at Holy Cross Catholic Church, a charming Florida church situated within an enclave of aged oak trees. Following the mass, my parents hosted an enchanting soiree at the Orchid Island Beach Club.

But like all good things, our fairytale wedding weekend eventually came to an end. Now, it's time to take care of some business items so that the IRS doesn't disturb our matrimonial bliss this tax season.

1. SOCIAL SECURITY NUMBER. The name on your tax return must match the name registered to your social security number. Use Form SS-5 to change your name with the Social Security Administration.

   This form must be supported by evidence of: (1) your age; (2) your identity; (3) your citizenship; and (4) your legal name change. An original or certified copy of your birth certificate can be used to prove your age and your U.S. citizenship; a passport may be accepted as an alternative. (Non-citizens must provide evidence of their immigration status). A driver's license or a passport can be used to prove your identity. Your marriage license can be used to prove your legal name change.

   Take or mail the completed Form SS-5, together with the supporting documentation to your local Social Security office. This form must be filled out using blue or black ink.

   All honeymoon reservations should be made using your maiden name. It typically takes several weeks for the marriage license to arrive in the mail, so you will not be able to obtain a new passport or driver's license in time for the honeymoon.
   

2. DRIVER'S LICENSE. Because your driver's license is your primary form of identification, you must also change your name on your driver's license. Most DMVs will issue a new driver's license upon presentation of the marriage certificate (i.e. from the church), but some will require a certified copy of the marriage license (i.e. from the State). Check with your local DMV before you go for its requirements. You will also need to bring your current driver's license.
3. CHANGE OF ADDRESS. Notify the U.S. Postal Service of any address change so that it may forward any mail from the IRS (e.g., refund checks, letters) by completing the Postal Service's official change of address form. The Postal Service will usually notify the IRS of your new address, but it is a good idea to notify the IRS directly of any address change by completing a Form 8822.
4. INFORM YOUR EMPLOYER OF NAME AND ADDRESS CHANGES. It is important to inform your employer of any name and address changes so that the information on your W-2s correspond with the name registered to your social security number and used on your tax return and so that you timely receive your W-2.
5. ENSURE CORRECT WITHHOLDING. Your newly combined incomes and marital status may subject you and your spouse to a higher or lower tax bracket. Ensure that your employers are making correct withholdings for federal taxes so that you do not end up overpaying or owing significant tax in excess of withholding. Check out the IRS Withholding Calculator to determine the correct amount of withholding.
   

SOURCES:

• IRS Summer Tax Tip: Advice to Newlyweds
• Social Security Administration FAQ: How to Change a Name on a Social Security Card