Tax Law Blog | IRS Tax Attorneys

The federal budget includes a plan to reverse a big decline in Canadian venture capital investment, starting with a change to tax law.

A long-time plea by Ottawa technology magnate Terence Matthews and industry lobbyists was answered when the government cancelled Section 116 of the Income Tax Act, which forces foreign investors to file Canadian returns when they sell investments.

“At a minimal cost to the government, this amendment will have an immediate, positive and direct impact on Canada’s ability to grow a robust Canadian technology industry,” Matthews said in a release. “By sending a clear message to international investors that Canada is ‘open for business,’ the government will make Canadian companies more attractive to foreign investors overnight.”

Matthews recently announced he was seeking investors for a $200-million investment fund to promote development of new companies.

Venture capital investment fell 27 per cent last year across Canada to $1 billion, the lowest in 13 years. Just $90 million was raised by Ottawa companies, half the amount they raised in 2008.

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Two senators Tuesday introduced a proposal to vastly simplify the nation’s tax code by cutting the number of income tax brackets in half and flattening the corporate tax rate.

The plan put forth by Sens. Judd Gregg (R., N.H.) and Ron Wyden (D., Ore.) would lower the number of marginal income tax rates to three: 15%, 25% and 35%. It also would eliminate the alternative minimum tax, which lawmakers scramble to “patch” each year in order to minimize its impact on middle-income taxpayers.

The plan would create a single corporate income tax rate of 24%, but allow small businesses with receipts of up to $1 million to expense all of its equipment and inventory costs.

The plan would target “direct payments and indirect subsidies to businesses each year,” but would leave it to the nonpartisan Congressional Budget Office to identify “the least productive” of those subsidies. Politically, that would be a tough task, as lawmakers fiercely guard subsidies that benefit their states and districts.

President Barack Obama has also called for tax simplification, and last year he tapped former Federal Reserve chairman Paul Volcker to head a task force on the issue. That task force hasn’t issued any recommendations, however.

In a statement, Messrs. Gregg and Wyden said they were aiming to alleviate the headache the tax code causes individuals and businesses trying to sort through its minutiae.

“For far too long, our tax system has been overly complicated, burdensome and unfair to taxpayers and to small businesses that are the economic engines of our nation,” Mr. Gregg said in a statement.

Messrs. Gregg and Wyden assert that the average individual or family earning less than $200,000 would do “as well or better” under their plan than current tax law, in large part because the plan would nearly triple the standard deduction.

“Many taxpayers who currently itemize will find it more advantageous to switch to the standard deduction which will both reduce their tax bills and eliminate the burden of maintaining records and receipts needed to document itemized deductions,” the plan states. Most taxpayers would be able to use a one-page form to submit their taxes, according to Messrs. Wyden and Gregg.

The capital gains tax also would see broad changes under the plan. The legislation would exempt the first 35% of capital gains income from the tax. Also, the first $500,000 of investment would be held for at least six months to be considered long-term capital gains income, and the next $500,000 would have to be held for a year to be considered long-term.

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In his suicide note, the computer software engineer who flew a small plane into a building with Internal Revenue Service offices in Texas on Thursday cited a 1986 tax law as a major motivation for his action.

The law, known as Section 1706 of the 1986 Tax Reform Act, made it extremely difficult for information technology professionals to work as self-employed individuals, forcing most to become company employees.

Many software engineers and other such professionals say that the law denies them the opportunity to become wealthy entrepreneurs and that it makes it harder to increase and refine their skills, eventually diminishing their income.

Harvey J. Shulman, a Washington lawyer who represented companies that supported the desires of software engineers to be independent contractors, estimated that the law currently affects at least 100,000 such people.

“This law has ruined many people’s lives, hurt the technology industry, and discouraged the creation of small, independent businesses critical to a thriving domestic economy,” Mr. Shulman said in an interview Thursday. “That the law still exists — even after its original sponsors called for its repeal and unbiased studies proved it unfairly targeted a tax-compliant industry — shows just how dysfunctional and unresponsive Democratic and Republican Congresses and our political system have been, even on relatively simple issues.”

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Federal tax law brought quite a few changes this year as the accompanying article explains. Your state return won’t require as much heavy lifting - and many of its changes are tied to the federal return.

The biggest surprise will be on Line 15 of your state form. You’ll be asked to figure out the surtax you owe. The surtax will - depending on your income - be either 2 percent or 3 percent of the amount on line 14.

You’ll owe a 2 percent surtax if you make: $60,000 up to $150,000 and your filing status is single; $80,000 up to $200,000 with head of household status; $100,000 up to $250,000 with married filing jointly status; $50,000 up to $125,000 with married filing separately status. Below those minimums you don’t pay a surtax. Above those maximums you pay 3 percent.

Here’s how Thomas Beam, spokesman for the state’s revenue department, explained it in an e-mail: If your filing status is “married filing jointly” and your N.C. taxable income shown on Line 13 of Form D-400 is between $150,000 you compute your “regular” state income tax on Line 14 and then multiply that amount by 2 percent. Add the result to your “regular” tax on Line 14 to give you your total tax liability. Then you subtract credits, withholding, payments, etc., to find whether you are due a refund or whether you have to pay additional tax.
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Some tax law is going to make me rich? What is this stupidity?

It’s not stupidity at all. For a long time the Roth IRA rules —

Aaah. The Roth IRA. I hate that thing. You know that between the royalties on my invention and the dividends on those stocks you told me to buy like Waste Management (NYSE: WM) and BP (NYSE: BP), I have too much income to be eligible for a Roth. Everybody keeps telling me how awesome they are but I can’t play. Why do you keep bringing it up?

Wait. What invention?

The automatic ginger-mincer. It’s huge in Asia.

An automatic ginger-mincer? Is that like a turnip twaddler?

Don’t laugh, funny boy, I’m making money just sitting here. And I’m going to be making more, too — wait until you see our new infomercial.

Uh-huh. Anyway, that’s the point I’m trying to make. They got rid of the income limits; not for contributions, but for conversions. As of the beginning of 2010, you can take your other retirement accounts and convert them to a Roth IRA, no matter how much money you make.

Why would I want to do that?

In a traditional IRA, or a 401(k), you put your money in before paying taxes on it. Then, when you’re retired and making withdrawals, it’s taxed like income. But with a Roth, you put your money in after taxes, and then it grows over time, and all of your withdrawals are tax-free.

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Residents facing hardships during the recession could find a little financial relief through a number of tax law changes this year, according to local accountants.

A number of new credits and expanded deductions could translate into tax savings for families, students, homeowners and vehicle buyers.

Taxpayers with three or more children and married couples may be able to take advantage of the benefits expansion this year. The Internal Revenue Service revised the earned income tax credit formula for the 2009 and 2010 tax years, making the credit available to more low- and moderate-income families, according to the agency.

The credit is a refundable tax credit, so a taxpayer can claim the credit even if taxes were not withheld from their paychecks or they owe no tax.

The credit amount has been increased to 45 percent of the family’s first $12,570 of earned income, according to Cathy Fulmer, a general manager at Liberty Tax Service.

“Even as the recession drags on, a fourth of all eligible low- and moderate-income workers are overlooking their legitimate claims to the refundable earned income credit according to the IRS,” Fulmer said. “Others caught in employment downswing circumstances who may have accepted jobs with lower wages may also be eligible to take advantage of the EIC.”

New vehicle owners can deduct state or local sales taxes or excise taxes on new cars, light trucks, motor homes and motorcycles purchased bet-ween Feb. 16, 2009, and Jan. 1, 2010, according to the IRS. The deduction can be used on multiple vehicles but is limited to $49,500 of the purchase price on each new vehicle, according to the IRS.

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The tax-filing deadline may be months away, but it’s not too early to start thinking about tax preparation.

There’s lots of help available for taxpayers, said Dan Boone, regional spokesman for the Internal Revenue Service. The official IRS Web site, www.irs.gov, includes IRS forms and publications and the latest tax tips and answers to frequently asked questions, he said. Services include a tax refund tracker, a withholding calculator, a payment agreement application and an employer ID number application.

“Be sure to go to IRS.gov, not .com or .org or anything else,” he said. “Taxpayers who do not have Web access can phone the IRS toll-free at 1-800-829-1040.”

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By KEN MILANI AND CLAUDE RENSHAW

This week, TAX TALK looks at some tax law changes that were enacted this year and might have an effect on you when preparing your tax return. Ordinarily, reading about changes in the tax law would be as exciting as reading about the history of canned food, but there are some interesting goodies for almost everyone this year. Keep in mind this is merely an overview and, as you know, most tax laws come with a lot of small print and heavy lifting.

American Opportunity Credit. This credit replaces the Hope Education Credit for college expenses (tuition, books, and supplies, but not room and board) and is now equal to 100 percent of the first $2,000 and 25 percent of the next $2,000 (for a total credit of $2,500). An added new wrinkle is that the refund is 40 percent “refundable,” which means that even if you owe no tax at all, you could still get a check from Uncle Sam for 40 percent of the qualified amount. For those with children in college, this is the best news since Donny and Marie went back on tour!

Energy Credit. A 30 percent credit that is applied to the cost of qualified energy saving improvements, up to a maximum of $1,500 in total expenditures over 2009 and 2010 (maximum credit amount is $450). Among the items covered by this credit are water heaters, windows, insulation, and heating/air

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More American homebuyers will get tax relief thanks to changes made to the First-Time Homebuyer Credit. H&R Block (NYSE: HRB) advises the popular credit is now more accessible to existing homeowners and first-time homebuyers in three ways:

1. Through a tax credit worth up to $6,500 for existing homeowners in the
market for a new home.
2. Through a new closing deadline of April 30, 2010 — extended from Nov.
30, 2009 — for the $8,000 First-Time Homebuyer Credit. Also, a special
provision gives taxpayers two extra months to close if they’ve entered
into a contract by April 30, 2010.
3. By increased phase-out limits that start at $125,000 for singles and
$225,000 for married filing jointly — up from $75,000 and $125,000
respectively. The new limits apply to homes purchased after Nov. 6,
2009.

Under the new requirements, an estimated 2 million Americans are expected to claim the tax benefit.* The IRS estimates 1.4 million people have already claimed earlier versions of the First-Time Homebuyer Credit.

“From seniors looking to downsize, to families wanting to move, to those shopping for their first home, this credit paves the way for more people to positively impact their taxes through the benefits of homeownership,” said Amy McAnarney, executive director of The Tax Institute at H&R Block.

Existing homeowners must have owned and lived in their current home continuously for five of the last eight years to claim the credit of up to $6,500. Taxpayers must close on the replacement home between Nov. 7, 2009 and April 30, 2010. If taxpayers have entered into a contract on a home by April 30, 2010, they have until June 30, 2010 to close.

“The tax credit of up to $6,500 for current homeowners could ease the sting of those wanting to move but worried they’ll take a loss in the down market,” McAnarney said. “More first-time and existing homeowners can take advantage of this valuable tax credit under the new law.”

A house must be valued at less than $800,000 to be eligible for the new $6,500 or the $8,000 credit for first-time homebuyers. Taxpayers can claim the credit on their 2009 or 2010 tax returns. A completed settlement statement must be attached to the return in order to claim the credit.

Owning a home can trigger many other tax benefits. Taxpayers should consult their tax professional to ensure they receive all the credits and deductions a new house affords them.

The Tax Institute at H&R Block is a leading source of tax expertise focused on individual taxpayers and the tax preparation industry. Through its staff of enrolled agents, CPAs and attorneys, The Tax Institute provides unbiased research, analysis and interpretation of federal and state tax laws. For more information, visit: www.thetaxinstitute.com.

*National Association of Realtors, Nov. 5, 2009.

On its Web site, Talbots boldly says it offers clothing “to flatter women of all shapes and sizes.” But the preppy Massachusetts-based retailer just failed in its effort to hide something else: taxable income from its home-state taxman.

In a recent little-noticed opinion full of fascinating detail, the Massachusetts Appellate Tax Board said Talbots ( TLB - news - people ) improperly avoided paying the 9.5% Massachusetts corporate excise tax on as much as $392 million of revenue by using “sham” transactions that “lacked economic substance.”

Specifically, the quasi-judicial board said the company set up a Delaware subsidiary with a single office in Illinois to hold the various Talbots trademarks. Making “royalty” payments to the subsidiary for use of the marks, Talbot then deducted the sums on its Massachusetts tax returns. Neither Illinois nor Delaware tax such revenue if legitimately structured in this fashion.

“Tax avoidance was the driving force,” and the “motive behind the formation of a wholly owned holding subsidiary,” the board declared.

It was not clear from the 54-page opinion how much Talbots might owe Massachusetts in back taxes covering 1994 to 2001, the years at issue in the case. Simple math using the $392 million figure at the 9.5% rate suggests $37 million, or 67 cents per Talbots share, plus any interest and penalties. However, in an e-mail, Julie Lorigan, a Talbots spokeswoman at the corporate headquarters in Hingham, Mass., said “only a portion” of the $392 million “is related to Massachusetts,” and presumably taxed there, and that any taxes owed would be further reduced by offsetting expenses.

Asked about the existence of similar tax litigation in other jurisdictions, Lorigan said, “There could be other states, but I have no further comment.”

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