by Roger Russell and John M. Covaleski
Washington -- Tax professionals fret that the upcoming tax season could set records for complexity as a result of so many tax law changes.
“It’s going to be a very difficult and complex filing season, because clients are not accustomed to keeping and giving you the kind of information you need,” said Alan J. Strauss, a New York-based CPA and attorney. Two areas where he predicted that tax preparers will be particularly challenged are helping their clients deal with taxation of dividends, and the alternative minimum tax, or AMT.
Even the federal government has acknowledged that tax complication is a major problem. “The complexities of tax law compliance are among the toughest regulatory burdens in our economy,” Treasury Secretary John Snow said in a mid-November speech to the Washington-based Tax Foundation. “I can’t think of any other kind of paperwork that puts a greater crimp in job creation than the many-thousand-page brick of the tax code and the productive resources that are wasted on complying with its rules.”
Mark Blumenthal, a partner with Big Four firm Deloitte & Touche’s Private Client Advisors Services Group, believes that AMT issues will be troublesome, “not only for affluent taxpayers but, surprisingly, also for middle-income executive taxpayers.” He noted, “The government estimates that two-and-one-half million taxpayers will be subject to AMT in 2003.”
“We’re doing multiple-year tax projections,” said Blumenthal. “You can no longer run just one year, you need to do it for 2003 and 2004 -- and, for many, we’re doing projections for 2005 and beyond. The reason is that many planning strategies used in past years won’t work this year, because many more clients will be subject to AMT this year. You need to grind the numbers to assess the effect of AMT.”
The 2003 reduction in the top rate to 35 percent, retroactive to January 1, was a boon to small business owners, S corporations and LLCs, as well as to individual taxpayers, according to Blumenthal. He cited the increase in Section 179 expensing and the increase in bonus depreciation, as well.
“The increase in bonus depreciation is huge,” he said. “It applies to assets acquired after May 5, 2003, and before Jan. 1, 2005, so one very effective tax planning technique for the small business owner or someone with self-employment income from being a director in a company that reports on Schedule C is to buy equipment -- for example, computers -- that would qualify for this expensing and depreciation.”
“Section 179 expensing and bonus depreciation are not tied together,” he continued. “You can buy a computer system for a quarter-million in December, and expense $100,000 of that, leaving you with an adjusted basis of $150,000. Then, you can take bonus depreciation on that amount, leaving you with $75,000 that would qualify for regular depreciation.”
Blumenthal noted that a complicating factor is the reduction in long-term capital gains after May 5. “Those gains are subject to 15 percent rather than 20 percent long-term capital gains. There are a number of issues that revolve around this kind of change. One is normal loss harvesting -- if you’re trying to offset capital gains against losses, you need to be aware that there are peculiar netting rules that can produce some surprising results.”
“Investment interest expensing also may be problematic,” he continued. “Under the new act, investment income that qualifies for the 15 percent rate doesn’t include dividends. You need to analyze and decide whether you need to elect out of special tax treatment for those dividends. To the extent you have AMT and investment interest expense, it becomes complicated -- this is a situation where you need to do a multi-year analysis.”
Snow is concerned about the retirement planning aspect of tax preparation this season. “Retirement account regulations are among the most complex in our tax code,” he told the Tax Foundation. “There are six different savings accounts with confusing and seemingly endless rules, making it more difficult for Americans to save for retirement.”
Now is a good time to distribute earnings from closely held family corporations, according to Strauss.
“The traditional goal was to accumulate in the corporation as much as you could, but now the situation is reversed,” he said. “This if the first opportunity to distribute earnings with the 15 percent dividend rate. It may be a good time to atone for past years when you might not have paid out as much as you should have.”
“We’re always training our staff for new legislation,” said Richard Salter, CPA, JD, LLM, a tax partner in Chicago area-based Gleeson, Sklar, Sawyers & Cumpata.
“You’re not doing yourself a favor by waiting until tax season to get ready,” he said. “We teach classes internally during the course of a year, so that everyone is current by tax season.”
One planning area Salter noted is the flexibility permitted by the depreciation rules. “Most of the articles talk about maximizing depreciation, but not everyone needs huge deductions,” he said.
“What if you don’t need a $225,000 deduction, but rather $75,000? By playing with whether to take a Section 179 expense, using straight-line versus accelerated, and bonus depreciation or not, you’ve got a lot of flexibility in where taxable income is going to wind up. One of the wonderful aspects of flexibility in depreciation is that you can wait until you do the return and target expenses to see what you need.”
“There’s a lot of play here,” he said. “Practitioners should realize that, in the right circumstances, they can hurt their client by maximizing deductions this year.”
For William Duvall, branch manager of the Manassas, Va., office of Fiducial Inc. one of the profession’s 20 largest firms, the key to a successful tax season is organization and planning. “Most successful firms have tax planning all year round,” he said. “We start updating our software in May. During the summer, we get supplies in, make sure our reference materials are current, and decide whether we need to hire additional staff.”
“One of the big issues about tax season planning is figuring out how to get the non-tax work done,” said Duvall. “People forget about the routine work that will fall by the wayside if you don’t watch out.”
Meanwhile, tax prep complications could open a tunnel in which preparers provide a shining light for their clients by uncovering tax savings.
Earlier this year, Congress’ Joint Economic Committee reported that median household income increased after taxes in 2002 because of tax relief legislation provided to middle-income Americans.
“The bottom line is that the tax relief legislation of recent years has cushioned many American families from the effects of an unusual combination of events affecting the economy,” said committee vice chair Jim Saxton.
After-tax income increased from $35,563 in 2001 to $35,812 in 2002, the committee reported. It added, “The rebound in 2002 left real median household income at a relatively high level, a level higher than those reached in the boom period leading up to 1998.”
The Chicago-based American Bar Association has weighed
in on the issue, saying that, “The sheer volume of tax law changes has made learning and understanding new provisions difficult for taxpayers, tax practitioners and service personnel alike. Compliance with the tax code is seriously undermined when taxpayers do not understand the tax law.”
On its Web site, the ABA said that it “supports the simplification of the tax laws to the maximum extent consistent with basic equity, efficiency and the need for revenue.”
