If you have an interest in a foreign bank account you may be subject to reporting requirements.  There are two pieces of legislation that relate to these accounts.  The Bank Secrecy Act requires that certain financial accounts based in foreign countries be reported to the Department of Treasury.  This act has been in place for a number of years and is commonly known as FBAR (Report of Foreign Bank and Financial Accounts).   The Foreign Account Tax Compliance Act (FATCA) was enacted in 2010 with the intent of identifying American account holders in foreign bank and requiring payment of taxes on income from these investments. 

Foreign Bank Account Reporting 

If you have a financial interest or signature authority over a foreign financial account you may be required to file Form TD F 90-22.1 with the Department of Treasury.  Note that this is not an income tax form and is not filed with the 1040.  The due date for the return is June 30 of the year following the calendar year being reported.  This is known as the Report of Foreign Bank and Financial Accounts and does not require the payment of taxes.

Financial Accounts

               A foreign financial account includes any savings or checking deposit in an account maintained with a foreign financial institution.  This includes savings and checking accounts in addition to any account in which the account has an equity interest in the fund, such as a mutual fund.  It does not include ownership of individual bonds, notes, or stock certificates held by the owner.  A foreign country is defined for this purpose as all geographical areas outside the United States, the commonwealth of Puerto Rico, the commonwealth of the Northern Mariana Islands, and the territories and possessions of the United States.

Who Must File

                There are two basic requirements for filing if you have a foreign financial account.  First, this applies to “United States persons.”  A United States person includes a citizen or resident of the United States, a domestic partnership, a domestic corporation, and a domestic estate or trust.  If you are a United States person, you must also have “signature or other authority over an account.”  This means the authority to control the disposition of money by signing a check or similar document.    Authority also exists if the person can exercise that power through direct communication with the financial institution.

               The second requirement is that the account must be reported if the aggregate value of foreign financial accounts in which there is a financial interest exceeds $10,000 at any time during the calendar year.  This requirement has a couple of provisions that can be easily overlooked.  First, the accounts are reportable if the value exceeds $10,000 at any time during the year.  Not the average balance for the year. For example, if $12,000 were deposited into an account one morning, then withdrawn the following day, a reporting requirement would be triggered, as the value of the account exceed $10,000.  Secondly, the reporting requirement is for the aggregate value of all foreign financial accounts.  Thus if there were two accounts, and the value of those combined accounts exceeded $10,000 at any time, the reporting requirement is triggered.

Reporting Issues and Penalties

                As mentioned, the FBAR is not an IRS form and is sent to the Department of Treasury.  The report is due June 30 and cannot be extended.  Form TD F 90-22.1 is available at www.irs.gov as well as the Department of Treasury Financial Crimes Enforcement Network website  (www.fincen.gov).

               All foreign accounts should be reported to the IRS.  On the 1040, Schedule B, Part III, lines 7a and b are required if you had over $1,500 of taxable interest or ordinary dividends or had a foreign account.  In addition if you received a distribution from a foreign trust or were a transferor or grantor of such a trust you must complete lines 7 a and b.  Schedule B of the 1041, 1065, and 1120 have similar requirements.  If required to check “yes” on these boxes, a failure to do so is interpreted as a willful failure to file if a TD F 90-22.1 is required.  In these cases, the reporting is limited to the existence of the accounts.  These accounts must be reported in detail on the TD F 90-22.1 if you are required to file the form.   

               Although there is no tax associated with TD F 90-22.1, there are significant penalties for not filing the return.  These penalties can be civil or criminal.  A willful failure to file may carry a criminal penalty of up to $250,000 and/or up to five years in prison.  Each missing FBAR is a separate crime.  A civil willful failure to file carries a penalty of up to $100,000 or 50% of the highest balance in each unreported account for the year.  If it can be demonstrated that the failure to file was not willful, the penalty would be much lower, frequently $10,000. 

               There are three important  points about the penalties. 

1. Penalties are assessed per account, not per return.
2. Penalties apply for each year of each violation.
3. Penalties can apply to each person with a financial or signature authority over the account.

It is readily apparent that the penalties can escalate quickly and can substantially exceed the balance in the foreign accounts.

Foreign Account Tax Compliance Act

                The Foreign Account Tax Compliance Act (FATCA) was enacted in order to combat U. S. tax evasion by taxpayers holding investments in foreign accounts.  This is somewhat controversial, as it raises privacy issues, especially for those having dual citizenship.  It has been referred to as the “Global Tax Evasion Law.”  A number of European banks and financial institutions have been closing brokerage accounts for all U. S. customers due to perceived “onerous” U. S. regulations.  There are three components to the Act.  The original effective date was January 1, 2014, but the IRS has delayed implementation.  Institutions now have until January 1, 2017, to begin withholding U. S. tax from clients’ investment gains.  However, procedures to meet FATCA reporting requirements must be in place by January 1, 2014.  One problem is that the IRS has not issued final FATCA laws, so the industry does not know what specific requirements it faces.

               The first section requires foreign financial institutions (FFI) to undertake certain identification and due diligence procedures in an effort to discover any U. S. account holders.   U. S. account holders are defined as U. S. persons or foreign entities with substantial U. S. ownership.  For any accounts that have been so identified, the FFI is to report annually to the IRS the balances, receipts, and withdrawals from these accounts.  The IRS is empowered to require participating FFI’s to withhold and pay to the IRS 30 percent of any payments of U. S. source income made to non-participating FFI’s, individual accountholders who have not provided sufficient information to determine if they are a U. S. person, and foreign entity account holders failing to provide sufficient information about the identity of its substantial U. S. owners.

               This section of FATCA is by far the most controversial, with significant push-back from banking and government officials who are balking at requiring them to become “extensions of the IRS” and assuming a significant financial burden in attempting to comply.  Seven countries have entered into model agreements to cooperate with the U. S. on FATCA.  Discussions with other countries are under way.  Some countries, such as China, have flatly refused stating that “China’s banking and tax laws and regulations do not allow Chinese financial institutions to comply.”  In other countries, legal action has been initiated to stop FFIs from compliance.

               The second section focuses on the account holders themselves.  It requires disclosure of foreign assets by filing Form 8938 with the annual 1040.  Threshold amounts for filing the form depend on filing status and residency. 

               The determination of living or not living in the United States is made by applying the bona fide residence or physical presence test applicable to the foreign earned income exclusion.

               The third section of FATCA closes a tax loophole that investors had used to avoid paying taxes on dividends by converting them into non-taxable dividend equivalents.

 Concerns

                There is concern that the United States has gone too far with the provision of this act, to the extent that some push back is anticipated from foreign governments.  According to the Treasury Department, they are currently in negotiation with at least 40 countries for FATCA agreements.  Thus far, only the United Kingdom and Switzerland have finalized a FATCA pact, but France, Germany, Italy, Spain, and Japan have pending agreements.

               It seems, though, that many institutions are waiting for the final rules before taking radical actions.  Once the IRS comes out with those rules, the foreign financial institution landscape will begin to clear.  Or at least, we can hope.

As one approaches retirement age, one decision that must be made is when to begin drawing Social Security benefits.  For those born 1943-1954 full retirement age is 66. It increases two months for each succeeding year until it reaches age 67 for those born 1960 or later.

The later you wait, the larger your benefits will be.  You can retire at age 62 and your benefits will be reduced by 25% over what you would receive at full retirement.  After full retirement age the benefits increase 8% for each year you defer receiving benefits, up to age 70.  Obviously, when to retire is partly a guessing game based on how long you anticipate living.

However, there may be an alternative that allows you to draw some benefits and still increase your eventual monthly benefit.  If you have reached full retirement age and your spouse is drawing Social Security, you may be eligible for spousal benefits.  Your spouse does not have to be full retirement age, just drawing benefits.  This can be from beginning prior to full retirement age or due to receiving disability benefits.  The amount of the spousal benefit will be one-half of the amount being drawn by the spouse.  So, if your spouse is receiving $1,500 a month in Social Security, your spousal benefit will be $750.  If you are divorced or your spouse (or ex-spouse) is deceased you may be able to draw spousal benefits based on their record.

Drawing spousal benefits does not affect the benefits based on your own record.  In fact, if you draw spousal benefits and continue to work or simply defer drawing on your own account, the benefits you receive on that account will continue to increase until you begin drawing on your own account or age 70.

Applying for spousal benefits is simple.  Just go to www.ssa.gov and start the application process to receive benefits.  You will be asked if you wish to draw spousal benefits.  Simply indicate that you choose spousal benefits and continue with the application.  The application will then be processed and will indicate that you wish to receive spousal benefits until age 70.  At that time, it will automatically switch to your benefit, assuming the amount is higher.  If you wish to start drawing on your own account prior to age 70, simply contact the Social Security Administration when you wish to begin your own benefits.

You’ve paid into Social Security all you working life, here is a chance to get a little extra back from it.

For many years, American taxpayers have cleaned out their closets, put stuff in a bag, and delivered it to the Red Cross, Goodwill or other exempt organization. Being diligent citizens, they got a receipt from the organization that stated “2 bags of clothes.” Then at tax time, we filled in line 17 (Non-cash charitable contributions) of Schedule A with $495 – just short of the requirement to file a Form 8383.

But let’s back up a minute and look at the rules regarding non-cash charitable contributions. If the total of your non-cash charitable contributions is less than $500, IRS rules allow you to enter that amount on line 17 of Schedule A and not provide any additional details with your return.

If your contributions are $500 or more, life gets a little more complicated and you have to complete Form 8283. This form asks for the name and address of the donee organization, a description of the donated property, the date of the contribution, when and how the property was acquired, its cost, its adjusted basis, fair market value, and how you determined FMV. Traditionally, the description of the donated property was something like “2 bags of women’s clothing,” “miscellaneous household items.” You get the picture – a vague, largely unsubstantiated deduction.

If the contribution is $5,000 or more, you must obtain a qualified appraisal and attach the appraisal to the return. You can deduct the cost of the appraisal as a miscellaneous itemized deduction.

In February, 2012, the U. S Tax Court disallowed donations made by a particular couple. The court ruled that the receipt they obtained from the charity did not contain an adequate disclosure of the property allegedly contributed. Additionally the receipt did not identify the quantity of the items donated, the age, quality, or condition of the items.

When making non-cash charitable contributions donors must have complete and proper acknowledgement of the donation including a description of the items and their condition. The donated property must be in “good used condition” or better. It is the responsibility of the taxpayer fulfill these obligations. In addition, the taxpayer must place a value on the property.

We recommend that taxpayers take two steps in order to assure that their contributions will be deductible.

First, make an itemized list of everything you donate, with an indication of its condition. Attach it to the receipt provided by the donee organization and it would be well if they would initial the list.

Second, you need to place a value on the donated property. This does not need to be done at the time of the donation and the donee organization does not need to see the value you place on the contribution.
Even if the total is less than $500 you should still keep a record that include this information in the event of an IRS audit or inquiry.

There are several ways that you can go about determining a value for the donated property. Checking local garage sales, thrift stores, or eBay selling prices of similar items can be valid approach. The trouble with this is that it takes time to do this, likely more time than it is worth.

A second approach is to utilize software that will place a value on the contributed property for you. In addition, this software will maintain a listing of the property donated, the condition, and the other required information. There are currently two programs that can be utilized for this purpose. It’s Deductible is published by Turbo Tax (It’s Deductible and Deduction Pro is published by H&R Block’s TaxCut (Deduction Pro). The best news is that these programs are free online. If you use Turbo Tax or TaxCut, the program will populate your return with the information you generate. If not, you can print out the results and enter them into your own software package, or give the print out to your tax preparer.

Don’t let the threat of an IRS audit hinder you from making charitable contributions – just be sure to maintain an adequate record of your donations.

There have been two developments in the taxation of cell phones in recent months.  These are important issues that have the potential to affect millions of employees and employers.  The first of these addressed the taxability of employer –provided cell phones.  The second addresses the issue of how the IRS will treat iPads and similar tablet computers.

The tax ramifications for employees with employer-provided cell phones has been an issue of considerable debate over the past few years.  The problem arose from the fact that cell phones were considered by the IRS as “listed property” meaning that substantiation of business use of the cell phone required highly-detailed records similar to what is required for automobiles.  The main problem with this was that virtually no one kept such records.  The Small Business Jobs Act of 2010 removed cell phones from the listed property category.  However, the Act did not address the taxability of the value of personal use of a cell phone by an employee or reimbursement of cell phone costs by an employer.

In September, 2011 the IRS addresses this issue.  Under the new guidance the IRS will treat the value of an employer-provided cell phone as excludable from an employee’s income, assuming that it is provided to the employee for noncompensatory business reasons. This means that the cell phone is provided as an essential part of his or her employment – reaching clients when away from the office or work related emergencies during off hours, for example.  A similar approach is provided for reimbursement of work-related costs of a personally owned cell phone.   It should be noted that the reimbursement cannot be a substitute for a portion of the employee’s regular pay.

It is recommended that organizations document for each employee the noncompensatory reasons for providing cell phones or reimbursing their costs.  This would include obtaining copies of the cell phone invoices and employee verification that the reimbursement is reasonable and necessary for the employee’s business needs.  Although not a direct tax issue, employers should have a written cell phone policy that is adhered to, in order to minimize or avoid liability issues arising from the employees’ cell phone usage.

In a related issue, the IRS has informally indicated that iPads and other tablet computers will be treated like cell phones for tax purposes.  When cell phones were removed as listed property, the law kept computers in that category.  Tablet computers produced somewhat of a dilemma as they have characteristics of both computers and cell phones.  Apparently, the IRS considers them more like cell phones than computers.  Hopefully, this is a step to removing computers from the listed property category since it is difficult to value the amount of personal use of these devices.

As we approach the end of 2011, it would be appropriate to review your tax situation before year-end and make any necessary adjustments.  Although it is possible that Congress will enact some last-minute tax changes, you should plan as if there will be no further changes in the tax law before year-end. We will look at some personal tax issues, then discuss a few business strategies to help you save on taxes.

Individuals

The cornerstone of tax planning is to (legally) accelerate deductions and defer income.  If you have stocks that are in a loss position, you might consider selling them before year-end, especially if you already have capital gains in the current year.  If you have some stocks that are showing gains do not sell them before December 31, and postpone the tax until a future year.  However, do not sell the stocks just to get a tax deduction.  I often counsel clients who have an unrealized loss on a stock to evaluate the stock in terms of its current cost.  “You thought this stock was a good buy at $50 a share.  It is now selling for $30.  Is it a good buy at $30?  If so, don’t sell it now.”

One of the easiest things to control in this area is the acceleration of deductions.  As an individual, bunch your itemized deductions if you are close to the standard deduction amount each year. That way you can itemize deductions in one year, and take the standard deduction next year.  Pay any outstanding medical bills before the end of the year if you are above the 7.5% AGI floor for these deductions.  If you place the amount on a credit card, it is deductible in the year in which it is posted to your account.

Accelerate any charitable contributions.  If the check is dated and postmarked prior to December 31, it is deductible in 2011.  A very attractive deduction is the contribution of appreciated capital gain property to a charitable organization.  In these situations you get a charitable contribution deduction for the fair market value of the donation, but you do not pay tax on the gain over your cost basis.  For example, you own some stock that cost you $10 a share.  It is now selling for $25 a share.  If you donate the stock to a qualified charitable organization, you get a deduction for $25 a share and pay no tax on the gain over your $10 cost.

If you normally take the sales tax deduction rather than deducting state income tax, you should be aware that this provision is slated to expire at the end of 2011.  It might be a good tax strategy to purchase a vehicle prior to the end of the year to take advantage of this deduction while it is still available.  This is also available for boats, motor homes and other major purchases on which you pay sales tax.

Businesses

For small businesses, you there are a couple of depreciation provisions that change as of December 31.  First, the amount of expenditures that qualify for the Sec 179 deduction is dropping significantly as of the end of the year.  Sec 179 allows small businesses to take a current deduction for the purchase of certain depreciable tangible personal property.  The expense limit for this deduction in 2011 is $500,000, but it drops to $139,000 at the beginning of 2012.

Secondly, the current 100% bonus depreciation provision expires at the end of this year.  This provision allows you to take depreciation of up to 100% of the cost of depreciable personal property placed into service in 2011.  In making purchases of depreciable assets in 2011 rather than 2012, you can expense more assets under Sec 179 or the bonus depreciation allowance.

If you own an interest in a partnership or S corporation and anticipate a loss for 2011, you should examine your basis to see if it is sufficient for you to fully deduct the loss.  If it is insufficient, take steps to increase your basis.

Self-employed individuals should consider setting up a retirement plan in order to reduce taxes and to help insure that you have provided adequately for your retirement.

Businesses can stock up on supplies in order to get a deduction for 2011 and reduce the tax bite this year.  In addition, examine your inventory and see if any of it is damaged or obsolete.  If so, take a write off for its cost.

Make sure your accounting records are up to date so that you know what your tax situation is, going into the last days of 2011.  You can’t make the right decisions without correct and current information.

Finally

For businesses and individuals, perform an overall financial checkup.  Assess your financial condition and your plans for the coming year.  Think about cash flow, retirement, health care, investment and estate planning.  Review your wills, health care proxies, and powers of attorney for any changes that need to be made.  It is never too early or too late to plan for the future.

I have only been able to hit the highlights of the laws in this short article.  If you wish more detail about any of these issues, feel free to contact me.  Or if you wish to discuss your tax situation as the year is ending, I will be glad to help evaluate your situation.

A recent article on this blog discussed the concept of an innocent spouse under IRS rules. An innocent spouse is one who stands has filed a joint return and is exposed to liability for additional taxes due to fraudulent activity on the part of the other spouse.  An innocent spouse is frequently confused with the doctrine of an injured spouse.  An injured spouse is someone whose refund is captured by the IRS to satisfy a debt owed by the other spouse.  An injured spouse claim, if accepted by the IRS, can prevent this from happening.  A claim is made by filing Form 8379 with the IRS.

First, some background.  When spouses file joint returns, each spouse is liable for anything that is included on the return.  In addition, there is joint liability for any omissions from the return.  This joint liability exposes both spouses to having their refund seized by the IRS to satisfy a debt owed by the other spouse. This includes taxes, past due child support, or a federal debt such as a student loan.  There are two ways to avoid having this happen.  Filing a return separate from your spouse will prevent the IRS from seizing your refund for debts of your spouse.  However, this may not be the optimal solution, as the filing of separate returns usually results in a higher total tax liability for the family.

The second approach is to make an injured spouse claim.  In order to qualify for such a claim six criteria must be met:

1. You must have filed a joint return with your spouse.
2. You must be expecting a tax refund.
3. You must have received notice that the IRS would keep your refund or has already kept the refund.
4. The refund was kept (or is expected to be kept) in order to pay your spouse’s past due tax, child support, or other federal debt.
5. You must have income reported on the joint return.
6. You made and reported payments or withholding from your income on the joint return.

To make an injured spouse claim, you should complete Form 8379 and send it to the IRS Center where you filed the return.  Attach copies of Forms W-2 and 1099-R for both spouses to the claim.

If you have not yet filed the return, you can attach Form 8379 to the return.  In this case, “Injured Spouse” on the upper right hand corner of page 1 of the 1040.

Once the claim for injured spouse relief is submitted and approved by the IRS, the IRS will separate the tax liability and payments for the two spouses.  If you have a refund coming, it will be sent to you and not applied to the debts of your spouse.  The IRS states that it takes about 11 weeks to process an injured spouse claim.  Most states also have injured spouse provisions, so you can check with the Department of Revenue in your state to determine if there is such a statute, and how to file a state claim.

Let’s suppose that you file a joint income tax return with your spouse in 2008.  Not an uncommon occurrence, millions of couples do so every year.  But from there, things go downhill and the two of you divorce two years later.  Thinking that the divorce and its financial ramifications are behind you, you start to move on.  Then one day you get a letter from your favorite Uncle Sam.  The IRS has just notified you that your income for that 2008 return you filed was grossly underreported and that you have a $50,000 tax obligation.  To make matters worse, you have no idea where your ex-spouse is and the IRS doesn’t know either.

As it turns out, your spouse was a compulsive gambler, unknown to you.  In 2008 there were significant gambling winnings that 1) you did not know about and 2) were not reported on the joint tax return.  When you signed that return, you affirmed that it was “to the best of your knowledge true, correct, and complete.”  Since you signed it, you can be held fully responsible for the accuracy of the return as well as the payment of tax.  But you say “Wait a minute!  It says to the best of my knowledge.  I did not know anything about this.”  To which the IRS will say “Prove it.”

Fear not.  TaxDoc, CPA is here.  You may be eligible for innocent spouse relief and you may escape having to pay this huge liability, even if no one can find your ex.  There are three types of innocent spouse relief:

1. Traditional innocent spouse relief
2. Separate liability election, and
3. Equitable relief.

To request relief under any of these types, you should file Form 8857, Request for Innocent Spouse Relief. Let’s look at each of these methods to help you determine the best route for you to take (other than the route to Togo, which has no extradition treaty with the United States).  Take note that an innocent spouse and an injured spouse are two separate, distinct tax doctrines.  An injured spouse is a topic for another day.

Traditional Innocent Spouse Relief

Under traditional relief, as with all three methods, the filing status must be married filing jointly.  The traditional approach can be utilized regardless of your present marital status.

There must be an understatement of tax due to an erroneous item attributable to the other spouse and the taxpayer did not know and had no reason to know of the understatement when signing the return.  Suppose the other spouse had some gambling or other income that was not reported on the return.  The taxpayer had no knowledge of this income.  Note, however, that the requirement goes further – “had no reason to know.”  The IRS test for this considers factors such as the taxpayer’s education level, experience and knowledge in the family’s finances, changes in family lifestyle, unusual or lavish expenditures, evasiveness or deceit on the part of the spouse, and if the taxpayer made reasonable inquiry about items on the return.

The traditional method is available without regard to whether the amount in question has been paid or not.  If it has been paid, the taxpayer will receive a refund if the request is granted.  The key to having the innocent spouse request approved under this method is “unfairness.” If the IRS deems that is it unfair to hold the taxpayer liable for the understatement considering all facts and circumstances of the case, relief will likely be granted.

Separate Liability Election

Under the separate liability election, the spouses must no longer be married, be legally separated, or have lived apart for at least 12 months.  There must be an understatement of the tax due to an item allocable to the other spouse.  If the tax in question has been paid, a separate liability election cannot be made.

The standard for knowledge under this approach is less strict, stating merely that the taxpayer did not have actual knowledge of one or more of the erroneous items.  If a separate liability election is granted, the IRS will allocate income and deductions to the husband and wife, each being responsible for their share of the tax liability.

Equitable Relief

Under equitable relief the basic requirement is that circumstances make the taxpayer’s liability inequitable.  Factors such as divorce, taxpayer hardship, abuse by the other spouse, or a divorce decree requiring the other spouse to pay the tax are taken into consideration in granting equitable relief.  However, there are also factors working against the taxpayer – the error attributable to the taxpayer, knowledge or reason to know of the deficiency, benefiting from the unpaid tax, or a divorce decree requiring the taxpayer to pay the tax.

The basic criterion is unfairness as stated under the traditional relief method.  However, equitable relief is available only if the taxpayer does not qualify for tradition or separate liability relief.

Under all the methods the IRS is required to notify the spouse or former spouse and allow him/her to participate in the determination of the amount of relief.

Any request for relief must have been made within two years of the first IRS collection activity.  This is written into the IRS code for the traditional and separate liability elections methods.  IRS rules have also limited equitable relief to the two-year window.

This rule, however, has recently been relaxed under Notice 2011-70, allowing a taxpayer to file for equitable relief as long as the period for the collection of taxes remains open for the tax years at issue.  If a prior claim for equitable relief has been denied due to the two-year rule, a taxpayer can re-apply for equitable relief.

In an ideal world, we would not have a need for innocent spouse relief.  Unfortunately, we do not live in such an ideal world, so mechanisms are in place to try and assure fairness for all involved.

The value-added tax (VAT) has been adopted by every developed country and most developing countries in the world.  There is, however, one exception –The United States.  That may be changing as there is currently discussion regarding its adoption in the U. S.

The value-added tax is a tax on goods and services and is collected at every step in the production chain.  This is unlike the sales tax, which is paid only on retail sales.  In a sense it is similar to sales taxes that are currently in place in 45 states as it is a consumption tax. VAT rates, obviously, vary from country, but in a survey of OECD countries, the rate varies from a low of five percent to a high of 24.5 percent.

How the VAT Works

As an example, assume that a 10% VAT is in place.  The VAT will be added at each step in the production process.  It starts when a manufacturer purchases raw materials and other items for $100.  The 10% tax will be added so the purchase costs the manufacturer $110.  Ten dollars is remitted to the government.

In the next step of the process the manufacturer completes its products and sells them to a retailer for $250.  Again, the 10% VAT is added, bringing the amount of the transaction to $275.  In this case, however, the manufacturer has already paid $10 in VAT, so the company takes a deduction for amounts already paid.  Fifteen dollars ($25 – 10) will be remitted to the government by the manufacturer.

When the consumer purchases these items for $600, the VAT is added, bringing the cost to the consumer to $660.  The retailer remits $35 ($60- 25) to the government.  In the end, the entire tax is borne by the ultimate consumer.

There can be exceptions, deductions, and credits granted for certain types of products and services.  As more exceptions are created, the system becomes less efficient and the amount of revenues raised decreases.  One needs only to look at the current complexity of the income tax system to realize how these complicate the system.  Most states have hundreds of exceptions in their sales tax systems, creating distortions.

Advantages

First, the VAT is an efficient way to raise revenue.  It is a broad-based tax, and somewhat self-enforcing.  Businesses at any stage in the production chain can take a deduction for taxes paid only if they can show that their seller paid the tax before them.  Thus businesses encourage each other to comply.

Related to this is a second advantage.  Because the tax is collected at various stages in the production process, the government does not lose a large amount of tax revenue when a single business evades the tax.

Third, the VAT is considered less of a drag on the economy than income taxes.  It has been shown that consumption taxes (such as the VAT or sales taxes) do not discourage savings as does the income tax.  As consumers save more, capital becomes available to business for additional investment and expansion.

Disadvantages

Some parties decry the fact that a VAT is a money machine, enabling additional government spending.  Although this is a factor to consider, this argument is refuted by Bruce Bartlett (The VAT and the Money-Machine Argument) on two points.  He first states that, contrary to popular belief, the trend in VAT rates is not upward.  Many countries have never raised the rate from inception.  Some have even lowered the initial VAT rate.  His second point notes that higher taxes are anti-inflationary and reduce purchasing power.  As purchasing power is reduced, consumers spend less and fewer taxes are collected.  According to Bartlett, the money machine scenario just does not hold true.

A second issue with the VAT is that it is a regressive tax.  Those in the lower income levels are disproportionately affected by such a tax.  Two ways have been suggested to overcome this factor.  First, similar to the situation with sales taxes, some goods can be exempted from the tax.  Groceries, medications, and children’s clothing are three frequently-mentioned exceptions that could be made.  A problem with this approach is that it gives companies an incentive to mislabel the products they sell in order to avoid the tax.  An additional problem lies in the definition of an exempted product.  For example, where is the distinction between groceries and food prepared in a restaurant?  Many supermarkets offer, in addition to groceries, deli services with prepared food.  Others even have sit-down areas where the food can be consumed.  There is no bright line distinguishing one from the other.

A second approach to overcoming the regressive nature of a VAT is to implement it in conjunction with an overhaul of the income tax, making the income tax more progressive.  Lower rates for lower income levels and higher rates for those in the upper income brackets would counteract some of the burden on the lower-income population.

A third problem with the VAT is how to tax services.  How much value is added in the preparation of a tax return or in financial planning?  One solution is to exempt such services, while another solution would define the value added would be determined.

Summary

There are hurdles to overcome before the VAT is implemented in the United States.  The federal government is currently running large deficits and this tax presents an untapped (for the federal government) revenue source.  This reason alone is sufficient to not dismiss the prospect of a VAT being implemented in the United States.  A second factor is that the United States is in the distinct minority in terms of nations that have a value-added tax.

Ideally, implementation of a VAT in the United States would be revenue-neutral.  Introducing a value-added tax, accompanied by a revamping of the income tax code, would seem to be the most palatable approach.  This revision of the income tax code should be coupled with lower overall rates with the result that the tax burden is not increased significantly on any one population segment.

There have been a couple of recent changes in the tax rules that will impact a large number of taxpayers.  The IRS announced increases in the mileage rates, effective July 1, 2011.  Interestingly, after indicating for much of 2011 that the rates were not going to change, they announced the changes as gas prices were declining.

For the first half of 2011, the rate for business mileage was 51 cents per mile.  Mileage incurred July 1 – December 31, 2011, will be subject to a rate of 55 cents per mile.  Moving and medical mileage likewise increased, from 19 cents to  23.5 cents per mile.

Mileage incurred for charitable organizations did not change remaining at 14 cents per mile.  This rate is designed to cover only the cost of gas and has no provision in the rate for depreciation, maintenance, or other ownership costs.  This rate is fixed by Congress and cannot be changed by the IRS.

It will be important to keep track of your business, moving, and medical mileage and separate those miles incurred January 1 – June 30 from those incurred after July 1, since a dual rate applies this year.

As always, a contemporaneous log of your mileage should be maintained in order to comply with IRS rules and regulations and to make sure that you capture all deductible mileage.

The second change announced by the IRS deals with the length of automatic extensions to file certain tax return.  Partnership, trust, and estate tax returns will now be subject to a five-month extension.  This change was enacted in order to force pass-through entities such as partnerships to file their returns and provide Form K-1 to the owners in time for the owners to file their 1040 by the extended date of October 15.

Corporations, including S-Corporations, retain the six-month extension.  However, this does not create a problem for stockholders, as corporations are due March 15 when operating on a calendar year.  The extended due date would then be September 15.

This change is a change for the good, as it eliminates an October 15 rush to complete partnership, trust, and estate returns in time to prepare the extended 1040’s for K-1 recipients.

Now that April 18 has passed it is not too early to start looking at what tax changes are in place for 2011.  Probably the most-asked question right now is “Will the IRS change the mileage rate?”  My answer is “I don’t know.”  In the past, the IRS has been reluctant to change the rate mid-year.  They did make changes in 2005 and 2008.  Most predictions I read seem to think that gasoline prices are at or near their top for now, which would argue against an increase in the rate.  I would expect the IRS to make an adjustment sometime soon, perhaps announcing an early effective date for the 2012 rates.

Another significant change in the tax law is not so much a change but a repeal of an upcoming change.  The Patient Protection and Affordable Care Act and the Small Business Jobs act of 2010 (SMJA) instituted sweeping increases in the requirements for when a 1099 must be filed.  This increase included a requirement to issue 1099’s for goods sold in addition to services rendered.  In addition, it required the issuance of 1099’s to corporations.  This requirement has been repealed by the Comprehensive Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011 (Where did they get that name?).

Other changes you will see for 2011 include an increased personal exemption amount, increasing $50 to $3,700 and an increase in the standard deduction as follows:

• Married filing jointly $11,600
• Head of Household     $  8,500
• Single                          $  5,800

In addition, the tax brackets have been expanded for inflation.  Rates remain the same through 2012.  The reduced capital gain rate is in effect through 2012 also.

The special itemized deduction for mortgage insurance premiums expired on December 31, 2010 and was not renewed.

The following provisions were extended through 2012 by the 2010 Tax Relief Act:

• $1,000 child tax credit
• American Opportunity Tax Credit for college tuition
• Increase in the Earned Income Tax Credit for taxpayers with three or more children

Looking further down the road, the law that allows homeowners to exclude income from cancellation of debt on their principal residence expires at the end of 2012.  The bankruptcy and insolvency exceptions will still be available, however.

The credit for residential energy-efficiency property expires at the end of 2016.  This is a credit for the installation of solar water heating equipment, photovoltaic or fuel cell equipment, geothermal heat pumps, or wind turbines in a primary or second home.  This is not to be confused with the energy-saving home improvement credit which expires at the end of 2011.

No doubt there will be other tax changes that come about between now and December 31.  That gives Congress a long time to create additional tax mischief.  Stay tuned – more is likely to follow.