Treasury Department Releases Study on Income Mobility of Individuals

The study on income mobility of U.S. taxpayers from 1996 through 2005 revealed that "a majority of American taxpayers move from one income group to another over time." The major findings of the study included:

  • approximately half of the taxpayers who began in the bottom quintile moved up to a higher income group within 10 years
  • about 55% of taxpayers moved to a different income quintile within 10 years
  • among those with the very highest incomes in 1996, the top 1/100th of 1%, only 25% remained in the group in 2005
  • median real incomes of all taxpayers increased by 24% after adjusting for inflation
  • real incomes of two-thirds of all taxpayers increased over the 10-year period

A Little Tax Humor -- With a Point

Suppose that every day, ten men go out for beer and the bill for all ten comes to $100. If they paid their bill the way we pay our taxes, it would go something like this:

  • The first four men (the poorest) would pay nothing.
  • The fifth would pay $1.
  • The sixth would pay $3.
  • The seventh would pay $7.
  • The eighth would pay $12.
  • The ninth would pay $18.
  • The tenth man (the richest) would pay $59.

So, that's what they decided to do.

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Senate Bill on Tax Patents Introduced

On Nov. 15, Senate Finance Committee Chair Max Baucus (D-MT) and committee ranking minority member Chuck Grassley (R-IA) introduced legislation to prohibit the Patent and Trademark Office (PTO) from granting patents for common tax strategies and tax planning inventions. 

“America's patent system promotes innovation and competitiveness in all industries. However, the growing number of attorneys and accountants applying for patents of tax strategies and techniques is cause for concern,” Baucus said. “Taxpayers should not have to pay a toll charge or worry that they're violating patent law when they try to file their tax returns. Tax practitioners should be able to provide advice and services to their clients without paying a fee to the patent holder.”

Grassley added that tax patents “undermine the integrity and fairness of the federal tax system. They put taxpayers in the undesirable position of having to choose between paying more than legally required in taxes or paying a royalty to a third-party for use of a tax planning invention that reduces those taxes. Congress needs to level the playing field and improve options for taxpayers.”

Texas Law on "Piercing the Corporate Veil"

The attached link contains a brief overview of some of the current status of Texas law on "piercing the corporate veil." Texas Law on Piercing the Corporate Veil.

Problems with Return Preparer Penalties

We previously commented on the new return preparer penalties and the problems they will cause. Richard Lipton provides some additional insight into those problems in RIA's Federal Taxes Weekly Alert:

First, Congress has created a “disconnect” under which a return preparer could be subject to penalty in a situation in which the understatement did not result in any penalty for the taxpayer.

For example, assume that a preparer does not disclose a position for which there is substantial authority but which the preparer doesn't believe is more likely than not to be correct. IRS determines that the position results in an understatement of liability. The taxpayer would not be subject to penalty because there was substantial authority for the position, but the return preparer would because the position wasn't disclosed. Congress could easily address this problem by providing that taxpayers (as well as return preparers) are subject to penalty any time that a position on a return wasn't reasonably believed to be more likely than not correct at the time the return was filed.

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Western U.S. Estate Tax Returns 50% Higher Than IRS Projections

At a California Tax Bar Conference on November 2, 2007, IRS Territory Manager for estate and gift taxes in the western United States, Charles Morris, noted that a much higher than anticipated number of estate tax returns are being filed. The IRS had anticipated approximately 33,000 returns would be filed in 2007. It now appears likely that about 50,000 estate tax returns (a 50% increase) will be filed.

The increase in filings occurs in the same year in which the IRS has substantially reduced the number of estate tax attorneys and other staff. As a result, the IRS is necessarily going to focus on specific areas that involve potential compliance issues.

The areas for compliance focus are the following:
  1. The family limited partnership and discounts for lack of marketability and minority interest.
  1. Sec. 2036(a)(1) retained control or enjoyment of transferred assets - Mr. Morris notes that the IRS has won "decision after decision" in that area.
  1. Valuation - partial interests in real estate continue to be a contentious area.
  1. New Sec. 6695A appraiser penalties - the substantial appraiser penalties will be assessed in 2008. Mr. Morris reminded tax advisors that there is no statute of limitations on the appraiser penalty.

Using a Vacation Home as a Retirement Vehicle

This idea comes from Christopher J. Fenn, CPA, in his article "Apply Weath Protection Strategies for 2007 and Beyond" published in WG&L's Practical Tax Strategies.

An alternative or supplement to qualified plans can be a vacation home, particularly for those with children. While the children are living at home, the family enjoys the “retirement fund” on weekends. After the children leave for college, the parents make the vacation home their principal residence. Up to $500,000 of the gain on sale of the former principal residence is tax free, while any remaining gain is currently taxed at 15%. Once the parents have owned and occupied the former vacation home as their principal residence for at least two years, they become eligible for another $500,000 exclusion on the later sale of that second principal residence.

In comparison, withdrawals from a taxable plan such as a 401(k) would be subject to the higher ordinary rate (up to 35%). If the parents decide not to sell the second principal residence and instead allow it to transfer to the children after death, the entire appreciation on the home would escape income tax because it would be treated as an inheritance.