Expanded 1099 Rule Invites Identity Theft

An obscure tax rule in the health care bill is a huge invitation to identity theft.

In case you missed it, the massive health care bill includes a tiny provision that will require all businesses to issue 1099 information forms to every company with whom they do business in excess of $600 per year, starting in 2012.

The form 1099 is presently required when a business pays more than $600 in a year for services provided by an independent contractor. The form is not required for the purchase of goods or for purchases from corporations. The health care bill would require every company to issue a 1099 for the purchase of goods or services from any business including corporations.

Apart from the huge increase in record keeping and reporting for both buyers and sellers, there is an aspect of this that has not been mentioned previously.

The company or person who issues a Form 1099 has to secure the Social Security or Tax identification number of the vendor and their address in order to complete the form.

That means every business will need to write or call every supplier to ask for the supplier's tax ID number. This is going to put a huge time burden on a business unless they choose to disclose their tax ID number in every document that represents an invoice or receipt for a sale of goods or services. And every business that buys goods or service will have to be sure that they have the tax ID number of the vendor in case they need it.

And, the 1099 form also requires the issuer of the form to include their name and tax I.D. number and address. So every business will have the tax ID number of every customer that buys more than $600 of goods or services. And every business will have the tax ID number of every supplier from whom they bought more than $600 in goods or services.

Rep. Dan Lungren (R-CA) has submitted a bill that would repeal this rule. Let's hope he gets a lot of support.

Vern

Past the Tipping Point and the Watershed

"The word "Tipping Point" ... comes from the world of epidemiology. It's the name given to that moment in an epidemic when a virus reaches critical mass. It's the boiling point. It's the moment on the graph when the line starts to shoot straight upwards." (The Tipping Point by Malcolm Gladwell)

The May 25, 2010 issue of USA Today included an article about "Private Wages Fall in Historic Pay Shift". The main point of the article is that the amount of compensation and employee benefits provided to government employees and the benefits provided by Social Security, unemployment insurance, food stamps and other social benefits was substantially greater than the wages and benefits paid to employees of private companies. According to USA Today, "Paychecks from private business shrank to their smallest share of (total) personal income in U.S. history during the first quarter of this year. ... A record low 41.9% of the nation's personal income came from private wages and salaries in the first quarter, down from 44.6% when the recession began in December, 2007".

So we have long passed the watershed event where total government benefits and employment compensation exceeds the income of the private sector. That is, more than half the economic income of the populace is derived from government. According to the Tax Foundation, the top 50% of the taxpayers (as measured by adjusted gross income) paid 97.11% of the Federal income tax. Thus, the lower income half of the U.S. population has no reason to support any effort to restrict, modify or eliminate the income tax. And it appears that a significant part of the top half (by income) also receives a substantial amount of government benefits, employment compensation or payments to government contractors whose employees indirectly depend on government spending.

In the 3rd quarter of the 20th Century, it was a common belief that government employees received less compensation and benefits for the same kind of work done in the private sector -- but that the government employees preferred the job security over the compensation and benefits. In the last quarter of the 20th Century, the common belief was that government employees enjoyed greater job security and employee benefits but lower wages than non government employees.

But it seems times have changed. USA Today reported in their March 4, 2010 issue that government employees received 20% more in compensation and benefits than similar employees in the private sector. So we have reached the point where a job in government offers higher pay, better benefits and far greater job security than a similar job in the private sector. So who chooses to work in the private sector? A relatively few who are able to secure wages and benefits at the top of the scale (some MBA's, doctors, lawyers, CPAs, engineers) and a lot of other people who aren't able to get a job with the government.

And, more than half the population derives more benefits from the income tax than they pay in income taxes.

Meanwhile, in little more than than a year, we have effectively nationalized health care, we are trying to legalize more than 12 million illegal aliens who are mostly non-taxpayers and are likely to get government subsidies and we are also trying to impose a costly "cap and trade" tax on the entire energy sector. That's in addition to spending more than a staggering $8.5 billion on nearly two dozen different bailout and stimulus programs. (Based on an analysis attributed to Bloomberg)

Is this what they mean by the tipping point when the line on the graph shoots straight upward?

Vern

The Greatest Threat to Your Wealth

Asset protection planning appeals to those of us who are constantly subject to lawsuits and predatory litigation. But the greatest danger to accumulated wealth is our government.

They can take an unlimited share of our income with the income tax. They can take a large bite out of the money we spend with an assortment of excise taxes, a national sales tax or value added tax. Although the estate tax is presently repealed for 2010, it isn't going to stay that way and they can set the estate tax at any level to consume any portion of an estate. They impose an exit tax on any unrealized gains and deferred income if we give up our citizenship or resident status. If they want, they could even impose an exit tax on assets and confiscate any percentage of our assets if we wish to leave. Obscenely excessive fines and penalties can be imposed for alleged money laundering or for failing to comply with a mind boggling assortment of very confusing laws. And, if we are merely accused of any one of a variety of crimes, they can confiscate our property under the forfeiture laws.

What can you do to protect your wealth from these threats?

As long as we are still a country of laws, we can look to the various laws to identify legal (allowed) ways to hold assets or to dispose of assets to children or grandchildren. For now, it is still legal to move money offshore, even though offshore assets may need to be disclosed each year. And, for now, each person can take their assets with them if they expatriate and settle up with the IRS on any untaxed gains or deferred income.

But it seems to me that the doors are closing on both domestic and offshore methods of asset protection if the government is the party that wants our assets. Hopefully, it is mostly because the far left lunatic fringe of the Democratic party is in control and they are pushing through every change they can that will move us closer to a Socialist society. Perhaps the Tea Party and the Conservatives can get rid of enough Democrats and Liberals this fall to put a stop to this crazy frenzy of "progressive" legislation. But it seems highly unlikely that anything that has already been turned into a law will be repealed. Our move toward the European style of Socialism is like taking three steps forward and two steps back -- but the momentum is clearly for more government rather than for less.

Meanwhile, there are relatively few legal structures that can survive a challenge by a rogue government -- which is what we will most surely have if the November elections do not result in a sea change in the Congress. So maybe it's time to invest some time and money in helping to "kick the rascals out" this fall. Otherwise, the only way I can think of to preserve your wealth will be to leave the U.S. after becoming a citizen of some other country. And if we don't kick enough rascals out this fall, even that option may be extremely limited.

That's my two cents.

Vern

The REAL Rate of Return

A few days ago, I came across an article about "The Law of Zero Return", which is a concept that was partly attributed to me. (See http://members.cox.net/mathmistakes/zeroreturn.htm)

The concept is that the combined impact of inflation and income taxes consumes all of the return from an investment.

But that's not exactly what I said or intended to say.

For any kind of investment there is a rate of return, which can be positive, negative or even zero. For example, a bond issuer may offer to pay interest at the rate of 5% on the face value of the bond. This is sometimes referred to as the investment rate or gross rate of return.

Most investors are also well aware of the concept of the "real rate of return", which is defined by investment professionals as the investment rate of return minus the inflation rate. Generally, the inflation rate is assumed to be the same as the rate of change in the Consumer Price Index. If the investment rate of return is 6% and the inflation rate is 2%, the real rate of return in 4%.

Most investors are also aware of the after tax rate of return. This is defined as the investment rate of return minus the rate of tax as a percentage of the investment. And it varies from one investor to another depending on their own marginal tax bracket. For a taxpayer who is paying the maximum 35% federal income tax plus a 5% state income tax on his/her investment income, the combined income tax is equal to 40% of the investment rate of return. So if the investment rate of return is 6%, the income tax rate on the investment income is 40% times 6%, or 2.4%. Thus, the after tax rate of return is 3.6%.

But few investment advisers like to talk about the after tax real rate of return. Perhaps that's because it is a very depressing concept for any fixed income investor.

If the rate of inflation is 2%, and the after tax rate of return is 3.6%, then the real rate of return after taxes is 1.6% on an investment that is paying a gross return of 6%.

Now here's the "fun" part.

If the rate of inflation increases, what usually happens to the gross rate of return?

It goes up, because the people who have money to lend don't want to get repaid in cheaper dollars.

So, let's assume that the expected rate of inflation increases from 2% to 4% and the gross rate of return increases from 6% to 8%. How will that affect the after tax real rate of return?

The taxpayer is still in the 40% federal and state marginal tax bracket, so his 8% is cut down to 4.8% after taxes. But now the rate of inflation is 4%, so the after tax real rate of return is 0.8% instead of 1.6%.

And if the rate of inflation rises to 8%, the investment rate of return would increase to about 12%. The tax rate would be 4.8%, leaving an after tax rate of return of 7.2%. But now the inflation rate is 8%, so the after tax real rate of return is - 0.8%.

The result is that as the rate of inflation increases, the investment rate of return generally increases by an equal percentage and the after tax real real rate of return will decrease.

Like many other elements in investments and economics, there isn't a perfect correlation between inflation rates and rates of return on fixed income investments. However, I did a study in 1986 of various fixed income rates and the CPI inflation rate from 1940 to 1986 and the correlation was very high. The difference is due to the fact that investment rates are set by investors who add the expected rate of inflation to the interest rate that they require. Thus, the inflation adjustment is based on projections of the rate of inflation by investors. The actual rate of inflation will turn out to be more or less, depending on how the Federal Reserve attempts to deal with the problem.

But whatever the Fed might choose to do, it's not a good idea to wish for higher interest rates because higher rates are usually an indication of increasing rates of inflation in the economy. During periods of low inflation rates, investment rates of return are generally very low. And when investment rates of return are very high (as in the late seventies), the rate of inflation is also high.

Vern

www.offshorepress.com

Rethinking the Tax Refund Argument

For many decades, tax accountants and financial planners have argued that overpaying your withholding during the year in order to get a big refund doesn't make financial sense.

if you underpay your estimated taxes, you may have to pay interest to the IRS. But if you overpay, you don't get any interest on your refund. Overpaying your withholding is like making an interest free loan to the IRS.

But a great many taxpaayers prefer to get a big refund because it's a pile of money that is often large enough to do something significant. They may use it to pay for a cruise or other kind of vacation. They might use it to buy some appliances or to make renovations in their home. Some of them will put it in the bank or a Section 529 plan to save for their children's future college expenses.

By contrast, it's difficult to do anything significant or satisfying with a few extra dollars each day or each week. A $3,000 refund will amount to $8.21 per day, $57.53 a week or $250 a month. In today's investment market, money market funds are paying about 1% interest. If the excess tax withholding was received each week and put in a savings account. it would generate about $15 of additional funds at the end of the year. However, that interest would be subject to income taxes. For a middle income taxpayer in a state that imposes income taxes, the tax would be close to 30% or $4.50 -- leaving a meager $11.50 of extra after tax money.

I've argued for over 40 years that getting a tax refund is wasteful. But when short term interest rates are below 1%, I can certainly understand why a lot of taxpayers prefer to overpay some taxes in order to get a bigger refund each year.

Making good financial decisions is important, but sometimes there are other important considerations.

Vern

The Income Tax Multiplier

If you haven't heard of the "money multiplier" or "fractional reserve banking" I encourage you to spend a few moments looking at the definition of each at Wikipedia. (See http://en.wikipedia.org/wiki/Money_creation#Money_multiplier and http://en.wikipedia.org/wiki/Fractional-reserve_banking)

Very briefly, it's the process by which banks can expand the money supply because -- as a group -- they are permitted to loan a percentage of the money they have on deposit. The Federal Reserve establishes a reserve ratio, which is about 10%. When a bank gets a deposit of say $1,000, it is allowed to loan as much as $900 to various borrowers. What do the borrowers do with the money? Well, they deposit it in another bank. The second bank is allowed to loan as much as 90% of $900. The third bank in the chain can then loan as much as 90% of $810. And so it goes until the original $1,000 has been expanded by a factor of 10. So the banking system now has $10,000 of deposits from various customers. If the reserve ratio were set at 20%, the multiplier would be 5 to 1 instead of 10 to 1.

But what about the income taxes that are collected by the government on those multiple deposits? Well, it depends on whether the money that is received and deposited is defined as "income" by the tax law.

For example, assume we have an average income tax rate or a flat tax rate of 20%.

Taxpayer # 1 gets $1,0000 of income and he deposits $1,000 in the bank. Then he writes a check for $200 to the IRS. The first bank is now able to make loans of 90% of $800. But wait, The second bank that gets the tax dollars is also able to make loans of 90% of the $200 in taxes. So the banking system still gets to expand the money in circulation by the same amount.

Two taxpayers now borrow the $900 from the two banks that received the money from the first taxpayer and from the IRS. They spend the money on non-deductible personal expenses -- but the people who receive that $900 have to treat it as income. They therefor deposit the $900 in their local banks and then send a combined total of $180 to the IRS.

So the original $1,000 circulates through the economy and expands the money supply by 10 to 1. But the IRS also benefits from the money multiplier because they end up collecting $2,000 -- which is 10 times the original $200 of tax on the initial $1,000 of income.

So the next time you have to pay the IRS $200, you should know that you have actually contributed about $2,000 to the government coffers through the income tax multiplier. ANd if you don't spend the money you borrow on things that generate income tax from the people you pay the money to, then the tax multiplier doesn't work. So if you don't want the IRS to get more money, invest your borrowed money instead of spending it.

Vern