Dear Congress

Regardless of where you fall in the political spectrum, the results of last month's midterm election showed the American public's general disdain for the group of Congress currently in power. And, while I don't have an overwhelming sense of joy or sadness over who specifically won or lost, I am excited that both the House and the Senate will be controlled by the same party which will hopefully lead to many accomplishments over the next few years. With that in mind, here are three suggestions of tax issues that Congress should work on while they have the majority. 

Depreciation

Depreciation is a complicated topic for most businesses because, under normal circumstances, for every dollar they spend on improving their facilities or buying new machinery and equipment, they only receive tax benefit for a fraction of that dollar.  Although taxpayers might not decide to buy or not to buy capital assets because of tax depreciation rules, if taxpayers are rewarded with higher deductions in the year of purchase then they feel they are getting more benefit from that purchase.  So Congress should bring back at least 50% Bonus depreciation, and they should make this a permanent rule so that taxpayers don't have to wait until the end of the year to see if Congress will extend the law again.  It is incredibly difficult for businesses to plan when they don't know the law at the beginning of the year.  

The Middle Class

Between the PEP and Pease, additional required Medicare withholding, and Net Investment Income Tax, there are some taxpayers technically in the "middle class" that are getting absolutely demolished from a tax perspective.  By the time you take away 20% of their itemized deductions, all of their personal exemptions, and another 3.8% of taxes for Medicare, effective tax rates for those in the middle class rocketed upward in 2013.  Now, a married couple with 3 children that jointly makes $350,000/yr might seem rich, but after taxes and tuition that $350,000 doesn't go as far as one would think.  These are the people managing America's businesses, funding college educations, and helping build a brighter future for our country.  Let's give them a break and at least let them keep a little more of their deductions and personal exemptions.  

Corporate Inversions 

Figure out why companies are moving overseas.  America has to find a common ground with its companies in order to continue to grow and prosper.  Kudos to the companies that have found a way to pay zero tax, but come on, in reality to conduct business in the USA will cost something.  Meet with business leaders and find a common ground, a way for the Treasury and the business to both benefit.

Thank you Congress, and good luck.  Hopefully you will have several accomplishments over the next 2 years that will make the Americans that voted you in proud of your efforts.

A Vote For the Tattletale

I recently read this story about a whistleblower that will be paid $30 million in connection with information they delivered about an ongoing fraud.  $30,000,000.  In comparison, Peyton Manning, QB of the Denver Broncos, will receive $15 million in guaranteed salary for 2014.  Is it fair that someone, a bonafide tattletale, should be compensated more for one instance of disclosure than one of the greatest NFL quarterbacks of all time?  (I'm not really a Broncos fan, but Peyton Manning is in the process of leading my fantasy football team to a third successful season in a row, so I'm his #1 fan right now).

Most enforcement agencies have whistleblower programs, like the IRS and SEC (Securities and Exchange Commission).  They all work in similar manners - if a civilian gives the agency information that is constructive enough to lead to the uncovering of a significant fraud, the whistleblower can be entitled to compensation for their efforts.  

This does not mean if you call the IRS and tell them you think your neighbor is cheating on their taxes, and they audit them and find $1,000 of unreported income, that the IRS will come to your door and hand you a fee.  The whistleblower programs are directed a much larger, nationwide and international frauds.    

For $30 million, is it worth being known as a tattletale?  Having been involved with financial statement audits for almost ten years, I seem to think that whistleblower programs are essential in our communities and especially in governments and large businesses.  During a financial statement audit, auditors perform a variety of procedures to detect material misstatements in the organization's financials.  Management takes responsibility for putting in place controls and protocols to prevent and/or detect fraud.  

In reality, rank and file employees take shortcuts and cut corners on a daily basis in order to get their job done.  And, if there is collusion between 2 or more employees with access to key financial components, it will be hard to detect by any auditor or semi-present manager.  However it might not be hard to detect by the shy, quiet employee in the corner that sees what's going on but is dismissed as a threat because of their lack of personality.  In the end, that employee has more potential to stop the fraud than anyone else involved.  

 $30 million is a lot of money, and is being rewarded to someone that helped uncover a mutli-billion dollar fraud.  It's a tough pill to swallow that a tattletale is being rewarded in that manner.  But whistelblowers are a key component of all organizations' fraud prevention and detection program.  

Renting to yourself

A common source of investment income is owning rental properties.  Rental properties can be tax advantageous in that, after considering depreciation, the property can have positive cash flow with little to no taxable profit.  Rental activities can also be tax beneficial because they are by definition "passive", and their losses in most cases can be used to offset other passive income.  This can be very helpful for taxpayers subject to the Net Investment Income Tax (NIIT), also known as the 3.8% Medicare surtax because passive income is considered Net Investment Income (NII).  

But, there is a situation where this is not applicable which involves "self-rental" activities.  A taxpayer is engaged in self-rental when a property is rented for use in a trade or business activity in which the taxpayer materially participates.  For example, a taxpayer owns a building personally.  The taxpayer rents that building to their business, a corporation, in which they are a majority stockholder and work full time.  This would be characterized as a self-rental activity because the taxpayer is renting the building to a business in which they materially participate.  

Self-rental activities are treated differently than normal rental activities when it comes to passive activity losses.  By rule, income generated from self-rental activities is treated as nonpassive, but losses are treated as passive.  The treatment of income or loss from the self-rental activities can have a significant impact on the taxpayer's tax situation as a whole.  If the taxpayer has a $1,000 income from a self-rental activity, and a $1,000 loss from a normal rental activity, those two activities do not "offset" under the passive income rules as they would if both activities were normal rentals.  The impact is instead of having a net $0 rental income on their tax return, the taxpayer ends up with a $1,000 net rental income and a $1,000 passive activity loss, which will most likely be suspended until future years when the taxpayer has other passive income.  

This is a big point of contention for taxpayers engaged in rental activities, because tax law defines all rental activities as passive no matter what, then in the fine print excepts self-rental activities.  The rule also unjustly penalizes taxpayers that, for tax or estate planning purposes, want to keep real estate assets from their businesses.  The business can be sold, merged, or closed but the taxpayer will always own the building.  

This has been a rule for many years, however has resurfaced under new scrutiny in 2013 in conjunction with the NIIT.  By treating income from self-rental activities as passive instead of nonpassive, a taxpayer can mistakenly reduce their NII subject to the NIIT and also their taxable income as a whole.  When a taxpayer reduces their NII by passive losses, they should be prepared to justify how they are treating their rental activities in the event that the IRS inquires as to whether the activity is self-rental or normal rental.  Taxpayers should also reevaluate their rental arrangements between themselves, businesses they work in, or other partnerships where they have ownership interest to ensure they are in compliance with the self-rental rules.  

Op Ed: A Millenial's View of Social Security

Social security is a pyramid scheme.  Bigger than Enron and Madoff and the calling cards Michael Scott was selling on The Office.  

I preface this by saying everyone that pays into the Social Security system (SS) deserves to benefit from those contributions at some point.  Receiving a SS check each month is evidence that you spent a long career working hard and you are benefiting from a system you paid into.  You can Google "social security benefits" and find hundreds of articles on when to start drawing SS, how spousal benefits work, and how much more you can get if you don't start drawing until 68 instead of 65.  These people are at the  "top of the pyramid".  But what about those of us at the bottom of the pyramid, looking up and wondering what will be left if we ever get to the top?  

SS was passed by Congress and signed into law by President Roosevelt in August 1935.  This was a part of a nationwide recovery after the Great Crash and depression in the late 20's and early 30's.  A complete history of SS can be found at the SSA website (in case you forgot it all from high school history like I did).  

In general, the program was designed to help older Americans that had lost all of their savings.  Almost 80 years later, the program is still in existence.  The program is funded through FICA taxes, which are withheld from an employee's paycheck at a rate of 6.2% and then matched by the employer.  Once an employee's wages reach a certain threshold ($117,000 for 2014) they are no longer subject to the FICA tax (Medicare never phases out, and is a whole other debate for another time).  

The problem is, every dollar a 30 year old worker puts into the system is paying benefits for someone in their 60s and 70s, hence the "pyramid".  The result is my kids will be paying the benefits for my parents, leaving my grandkids to pay for my benefits.  Furthermore, the SS system is heavily underfunded, meaning that it projects to have greater liabilities in the future than expected assets/income.  This is why you will hear some politicians suggest raising the minimum age when Americans can begin to draw SS benefits - so as to delay the number of new people signing up for benefits a little bit further down the road.  

In a perfect world, I would like the option to not contribute to the SS system, and also bypass the future benefits.  I have been educated on retirement accounts and insurance and understand my responsibility for myself and family in retirement.  Unfortunately that is not feasible for a variety of reasons, mainly being that if I quit contributing to the system, they will not be able to meet their current liabilities.  You can't do away with the program, because It would be impossible to draw a line in time and say "everyone from this age and older gets it, and everyone younger doesn't get it".  You also can't apply income limits, because the higher wage earning Americans pay more into the system through the FICA taxes.  

Absent any major overhauls, the greatest looming problem in my opinion, especially for Millenials, is that eventually the government will have to find a way to rectify the deficit in the SS program.  According to the 2014 Trustees Report, SS and Medicare payments accounted for 41% of all Federal expenditures in fiscal year 2013.  Since these benefits are set in stone and will increase as more baby boomers hit retirement, the only way to fix the deficit is to raise revenue i.e. some form of taxation.  It could be in the form of higher FICA rates which would affect take-home pay, or it could be in the form of a special "other tax" like the net investment income tax that is designed to siphon tax revenue from a specific group of taxpayers.  

If you are currently drawing SS or will be drawing it in the next 10 years - thank you for your years of hard work contributing to our economy.  You deserve the benefits from the system you paid into, and I will gladly pay in so that you can reap the rewards of your long career.  But I'm not counting on anything for me because in the next 35 years someone will figure out that the system is broken and unsustainable.  And I'm not sure my grandkids will be as willing to foot the bill as I am.

Idea$ 2014 - August: Credit Cards

In the world of personal finance credit cards have a bad reputation.  They can give people a false sense of how much money they can spend and lead to high interest and finance charges.  But, if used with appropriate discipline, credit cards can be a powerful tool in your financial universe.  What follows is a look at different types of credit cards and some of the best ways they can be used.  

Disclaimer

Before we begin, I will offer the disclaimer that I have found there are two golden rules when it comes to credit cards.  First, never spend more on the card than you can pay off when the bill comes due.  Second, always pay the card off each month i.e. never carry a balance.  By following these rules you will never have to pay interest or finance charges on your card, which can be large sums and lead to ultimate financial ruin.  

Cashback cards

Credit cards with a cashback feature provide the cardholder with cash in conjunction with certain purchases they make with the card.  One of the most popular is Discover's 5% Cashback Bonus program.  This program gives the cardholder cash back of up to 5% on qualifying purchases, which vary during the year.  For example, right now users of this card get cash back on all of their gasoline purchases through the end of September.  If you spend $100 on gas this month, you will get $5 credited to your cashback account which can be used to pay your bill, buy merchandise, or transferred to your bank account.  Cashback cards are great tools for people that only use a credit card for certain purchases, like gas and groceries.  

Cards with points

Credit cards that offer a points structure come in many different forms.  You have American Express, which gives you points on each purchase that you make.  These points can be used to buy merchandise from American Express, used on their travel website, or even used at Amazon to buy merchandise.  Then you have travel cards with airlines which give you miles instead of points.  These miles can be cashed in for plane tickets once you have earned enough.  Finally, you have store credit cards which give you points to be used as discounts on future purchases.  These cards are good tools for people that use credit cards a lot, buy a ton of plane tickets, or are always buying new things at their favorite store.  Plus, many of these cards have bonuses where, once you have spent a certain amount of money on the card during the year, they will give you extra points!  These cards are also great for people that have a lot of work expenses that are reimbursed.  If you have to buy your own plane ticket for a work trip and submit your receipt for reimbursement, you get to keep the points.  I don't see anything wrong with using credit card points to get a new set of golf clubs because you were on 25 airplanes last year!

Store credit cards

Store credit cards is an area where you can get the most bang for your buck with the proper discipline.  Here's a common example.  You need to buy a new refrigerator that's going to cost $2,000, but you don't have that kind of cash right now.  You see on the TV that your local appliance store is running a zero payments / zero interest for 18 months special on their store credit card.  The rules of these promotions are pretty simple - the interest on the purchase accrues for 18 months and then hits as soon as that period expires.  The trick is, if you pay the card off before the 18 months, you pay zero interest.  Basically, the store has financed the purchase for you.  So you go down to the appliance store, buy the refrigerator with their credit card, and then take the balance and divide by 17.  You divide by 17 to make sure you pay the card off before the promotion ends.  Make that payment each month and - voila! - now you have a new refrigerator, and you paid no interest or finance charges.  This is the only situation where the golden rules discussed above do not apply.  

Conclusion

In conclusion, credit cards can be a useful financial tool if used correctly.  By never carrying a balance and always paying the card off at the end of the month, you can earn cashback or points and a little more interest on your checking account.  A helpful tool is to treat credit card transactions just like they are cash transactions on your budget.  Look at your statement each week and make sure you are not overspending.