The Taxes You Don't Think About

Steve Parrish for Forbes writes:  We’re in the middle of the dreaded tax season. All the year’s blood, sweat and tears are temporarily boiled down into one simple question: How much do I owe the government? It is difficult in this environment to gaze out any further than our green eye shades, but may I humbly suggest we start paying attention to what the future holds? 

With all of the wrangling in Congress, most tax policy commentators have focused on federal income tax brackets. Yet, there are so many other ways the government may take our hard-earned money right out of our pockets. Below are just a few examples of how the taxing authorities affect what a business owner can keep. This checklist is meant to be a cautionary tale, reminding us to check our left pockets to see what else is being taken while we are reaching in our right pocket to pay our annual federal taxes.

• State income taxes – We all know that states vary radically on the income taxes they charge their residents and businesses. The example of no tax Florida and big tax New York is legendary.  Due to the fragmented nature of the economic recovery, however, this divide between states may become even more pronounced and varied. Consider, for example, that while Illinois is having its well-publicized revenue melt-down, the state to its west, Iowa, is arguing about whether to return a budget surplus to its citizens in the form of reduced taxes.
• Local taxes – With Detroit in receivership, we are painfully aware of the challenges some cities are facing. A recent report by the Office of Revenue Analysis in Washington D.C. demonstrates how much variance can exist. According to their report, a family of three earning $75,000 in Cheyenne, WY paid just $2,808, or 3.7% of its income in local taxes. Whereas in Bridgeport, CT, that same family would have paid $16,105, or 21.5% of its income. This is excluding federal taxes.
• “Subtle taxes”– For all the fuss that swirls around Congress over tax rates, the more punitive taxes to consider are the subtle, more arcane taxes. An example is the “employer mandate” tax associated with the Affordable Care Act. Starting in 2014, this can increase the employer’s tax burden as much as $2,000 per employee. Another example is the increasing use in the tax code of “phase outs”.  Three phase outs that attract notice as a result of the American Taxpayer Relief Act of 2012 (ATRA) are the PEP, Pease and Alternative Minimum Tax (AMT) phase outs. In sequential order, these phaseouts erode the value of 1) a taxpayer’s personal exemptions, 2) one’s itemized deductions and 3) the $80,800 floor exemption (couple filing jointly) from the AMT. Your tax bracket doesn’t go up, but your taxes do.
• Valuation obfuscation – For years I’ve followed the dance that goes on in the federal court system over the valuation for estate and gifts taxes of assets, particularly business interests. A few years ago, an estate valued the decedent’s business at $1.7 million, while the court ended up valuing that same business at $13.5.The additional estate taxes would alone be more than double the value the estate placed on the business. A very recent case involved art work that all parties agreed was worth $35 million. The question was what discount to apply for tax purposes. The estate claimed a 44.75% discount, the IRS asserted no discount applied, and the Tax Court arbitrarily came up with a 10% discount. Now that the federal gift and estate tax rate increased to a whopping 40%, these disputed valuations are more than an idle curiosity!
• Reform – Proposed law is exactly that … proposed. However, keep an eye on pitches circulating in Congress dealing with the taxation of businesses. These proposals may foretell big changes for small business owners. On March 19, House Ways and Means Chairman Dave Camp proposed a tax-overhaul bill that could simplify how millions of small firms organize and operate for tax purposes. With simplification, however, comes significant change. One version of this proposal would take away the tax distinctions between S Corps, LLCs and partnerships. Further, small businesses would become subject to federal tax withholding rules; the effect being that business owner taxes on profits would be withheld by the company itself.

As we wrap up the tax season, it pays to look to the future. Being aware of hidden taxes, imminent tax changes and proposed tax law gives us the opportunity to act. We can change our tax strategy, gear up for additional taxes and lobby to make sure our interests are being heard.