How Turbo Tax killed free and simple tax filing

Liz Day for Pro Publica & The Raw Story writes: Imagine filing your income taxes in five minutes and for free. You’d open up a pre-filled return, see what the government thinks you owe, make any needed changes and be done. The miserable annual IRS shuffle, gone.

It’s already a reality in Denmark, Sweden and Spain. The government-prepared return would estimate your taxes using information your employer and bank already send it. Advocates say tens of millions of taxpayers could use such a system each year, saving them a collective $2 billion and 225 million hours in prep costs and time, according to one estimate.

The idea, known as “return-free filing,” would be a voluntary alternative to hiring a tax preparer or using commercial tax software. The concept has been around for decades and has been endorsed by both President Ronald Reagan and a campaigning President Obama.

“This is not some pie-in-the-sky that’s never been done before,” said William Gale, co-director of the Urban-Brookings Tax Policy Center. “It’s doable, feasible, implementable, and at a relatively low cost.”

So why hasn’t it become a reality?

Well, for one thing, it doesn’t help that it’s been opposed for years by the company behind the most popular consumer tax software Intuit, maker of TurboTax. Conservative tax activist Grover Norquist and an influential computer industry group also have fought return-free filing.

Intuit has spent about $11.5 million on federal lobbying in the past five years more than Apple or Amazon. Although the lobbying spans a range of issues, Intuit’s disclosures pointedly note that the company “opposes IRS government tax preparation.”

The disclosures show that Intuit as recently as 2011 lobbied on two bills, both of which died, that would have allowed many taxpayers to file pre-filled returns for free. The company also lobbied on bills in 2007 and 2011 that would have barred the Treasury Department, which includes the IRS, from initiating return-free filing.

Intuit argues that allowing the IRS to act as a tax preparer could result in taxpayers paying more money. It is also a member of the Computer & Communications Industry Association (CCIA), which sponsors a “STOP IRS TAKEOVER” campaign and a website calling return-free filing a “massive expansion of the U.S. government through a big government program.”

In an emailed statement, Intuit spokeswoman Julie Miller said, “Like many other companies, Intuit actively participates in the political process.” Return-free programs curtail citizen participation in the tax process, she said, and also have “implications for accuracy and fairness in taxation.” (Here is Intuit’s full statement.)

In its latest annual report filed with the Securities and Exchange Commission, however, Intuit also says that free government tax preparation presents a risk to its business.

Roughly 25 million Americans used TurboTax last year, and a recent GAO analysis said the software accounted for more than half of individual returns filed electronically. TurboTax products and services made up 35 percent of Intuit’s $4.2 billion in total revenues last year. Versions of TurboTax for individuals and small businesses range in price from free to $150.

(H&R Block, whose tax filing product H&R Block At Home competes with TurboTax, declined to discuss return-free filing with ProPublica. The company’s disclosure forms state that it also has lobbied on at least one bill related to return-free filing.)

* * *

Proponents of return-free filing say Intuit and other critics are exaggerating the risks of government involvement. No one would be forced to accept the IRS accounting of their taxes, they say, so there’s little to fear.

“It’s voluntary,” Austan Goolsbee, who served as the chief economist for the President’s Economic Recovery Advisory Board, told ProPublica. “If you don’t trust the government, you don’t have to do it.”

Goolsbee has written in favor of the idea and published the estimate of $2 billion in saved preparation costs in a 2006 paper that also said return-free “could signiFB01cantly reduce the time lag in resolving disputes and accelerate the time to receive a refund.”

Other advocates point out that the IRS would be doing essentially the same work it does now. The agency would simply share its tax calculation before a taxpayer files rather than afterward when it checks a return.

“When you make an appointment for a car to get serviced, the service history is all there. Since the IRS already has all that info anyway, it’s not a big challenge to put it in a format where we could see it,” said Paul Caron, a tax professor at University of Cincinnati College of Law. “For a big slice of the population, that’s 100 percent of what’s on their tax return.”

Taxpayers would have three options when they receive a pre-filled return: accept it as is; make adjustments, say to filing status or income; or reject it and file a return by other means.

“I’ve been shocked as a tax person and citizen that this hasn’t happened by now,” Caron said.

Some conservative activists have sided with Intuit.

In 2005, Norquist testified before the President’s Advisory Panel on Federal Tax Reform arguing against return-free filing. The next year, Norquist and others wrote in a letter to President Bush that getting an official-looking “bill” from the IRS could be “extremely intimidating, particularly for seniors, low-income and non-English speaking citizens.”

Norquist, founder of Americans for Tax Reform, declined to comment, but a spokesman pointed to a letter he and other conservatives sent this month to members of Congress. The letter says the IRS wants to “socialize all tax preparation in America” to get higher tax revenues.

A year after Norquist wrote Bush, a bill to limit return-free filing was introduced by a pair of unlikely allies: Reps. Eric Cantor, R-Va., the conservative House majority leader, and Zoe Lofgren, D-Calif., a liberal stalwart whose district includes Silicon Valley.

Intuit’s political committee and employees have contributed to both. Cantor and his leadership PAC have received $26,100 in the past five years from the company’s PAC and employees. In the last two years, the Intuit PAC and employees donated $26,000 to Lofgren.

A spokeswoman said in an email that Cantor “doesn’t believe the IRS should be in the business of filling out your tax returns for you,” and that the bill was designed to “prevent the IRS from circumventing Congress.”

Lofgren did not respond to requests for comment.

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Intuit did not issue public statements on the return-free filing bills, but CCIA President Ed Black has called return-free filing “brilliantly Machiavellian.” When Sens. Ron Wyden, D-Ore., and Dan Coats, R-Ind., introduced a bipartisan tax reform bill in 2011 that included a return-free plan called “Easyfile,” Norquist blasted it.

“The clear goal of this measure is to raise taxes in a way that leaves politicians with clean hands,”he wrote in a letter to the two senators.

Political opposition hasn’t been the only hurdle. Supporters say return-free filing has been overshadowed in a tax debate that has focused more on rates, deductions and deficits.

Further, return-free filing would not be available to everyone. It’s best for the slice of taxpayers with straightforward returns who don’t itemize or claim various credits.

Still, past studies estimate that this group might include 40 percent of filers or more; the IRS expects to process 147 million individual returns this year.

In separate reports, the CCIA and a think tank that Intuit helps sponsor argue that potential costs outweigh return-free filing’s benefits. Among other things, the reports say that not many taxpayers are likely to use return-free, that new data reporting requirements could raise costs for employers, and that taxpayers could face new privacy and security risks.

The reports and Intuit also note that many taxpayers can already get free tax filing through the Free File Alliance, a consortium involving the IRS and a handful of companies. But last tax year, only about 3 million filers had used Free File, according to a Treasury tally through April 28.

In an SEC filing, Intuit said it provided about 1.2 million free federal returns for the 2011 tax season. The company and competitors typically advertise free federal filing on the Web but also pitch other paid services, such as filing certain state returns.

Government studies have split about whether a return-free system would save or cost the IRS money, according to a 2003 Treasury report. Unless the tax code was simplified, the report said, it would add work for employers and the IRS, which would have to process tax records sooner.

Some independent tax experts see potential problems with a return-free system.

Eric Toder, co-director of the Urban-Brookings Tax Policy Center, said the IRS, “an overpressed agency that’s being asked to do a lot of things,” shouldn’t be asked to do what software companies could easily do.

James Maule, a professor at Villanova University School of Law, said the average taxpayer probably wouldn’t scrutinize a pre-filled return for accuracy or potential credits. “Some people might get this thing that says this is your tax bill and just pay it, like with property tax bills,” said Maule.

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So far, the only true test case for return-free filing in the U.S. has been in Intuit’s home state.

In 2005, California launched a pilot program called ReadyReturn. As it fought against the program over the next five years, Intuit spent more than $3 million on overall lobbying and political campaigns in the state, according to Dennis J. Ventry Jr., a professor at UC Davis School of Law who specializes in tax policy and legal ethics.

Explaining the company’s stance, Intuit spokeswoman Miller told the Los Angeles Times in 2006 that it was “a fundamental conflict of interest for the state’s tax collector and enforcer to also become people’s tax preparer.”

The following month, an ad in The Sacramento Bee, paid for by the CCIA, cautioned “Taxpayers beware” and said ReadyReturn “could be very harmful to taxpayers.” The ad pointed to a now-defunct website, taxthreat.com, opposing ReadyReturn.

Former California Republican legislator Tom Campbell recalls being surprised at the opposition.

“The government imposed the income tax burden in the first place,” he told ProPublica. “So if it wants to make it easier, for heaven’s sake, why not?”

In a Los Angeles Times op-ed at the time, Campbell wrote he “never saw as clear a case of lobbying power putting private interests first over public benefit.”

Joseph Bankman, a Stanford Law School professor who helped design ReadyReturn, says he spent close to $30,000 of his own money to hire a lobbyist to defend the program in the legislature. Intuit made political contributions to scores of legislative candidates, Bankman said, and gave $1 million in 2006 to a group backing a ReadyReturn opponent for state controller.

ReadyReturn survived, but with essentially no marketing budget it is not widely known. Fewer than 90,000 California taxpayers used it last year although those who do use it seem to be happy. Ninety-eight percent of users who filled out a survey said they would use it again. The state’s tax agency has also praised ReadyReturns, saying they are cheaper to process than paper returns.

Bankman thinks national return-free filing could make many others happy, too. “We’d have tens of millions of taxpayers,” he said, “no longer find April 15 a day of frustration and anxiety.”

Help I’m Being Audited! The Many Ways to Pay

Marilyn Calister for WTAS writes: IRS will request information from the taxpayer and based on the responses provided, IRS will:

1. Claim that additional tax is owed by the taxpayer;
2. Determine that a refund is due to the taxpayer; or
3. Issue a "no change" letter.

In the case where a refund is due or there is no change, the taxpayer will exit the audit process. However, when the audit concludes and additional tax is owed, the taxpayer can choose to appeal the determination or pay the tax. Even if a taxpayer disagrees with IRS' determination, there may be reasons why a taxpayer would choose to pay the balance owed versus appealing. The amount owed may be immaterial relative to the cost of an appeal. Also, a high-profile taxpayer, who continues on to Appeals but without success, might choose to pay the tax rather than moving to the next level where the dispute will become part of the public record. As mentioned in our previous article, once the dispute reaches the Tax Court, the taxpayer's identity will become part of the public record and many high-profile taxpayers may wish to retain anonymity with respect to their private tax matters. A taxpayer has a number of options to consider when paying a balance due. This article will focus on those options.

Option #1 – Write a Check

The most obvious and easiest method to pay a balance due is simply to write a check. An audit determination will usually contain a remittance advice with instructions on how to pay IRS. The taxpayer merely needs to attach a check made payable to the "United States Treasury" and mail it to the address indicated. IRS will credit the taxpayers account for the year, or years, in question and this will complete the audit. However, not all taxpayers have the funds to pay a balance due resulting from an audit. In this situation, IRS does provide alternative payment methods.

Option #2 – Request an "Installment Agreement"

The Installment Agreement is the method of choice for a taxpayer who has the assets to pay the audit assessment, but due to illiquidity, they cannot be easily converted into cash. This agreement allows the taxpayer to pay the balance due over time. IRS generally has 10 years to collect a liability and will not enter into an agreement that lasts beyond this limit. When requesting an installment payment plan, the taxpayer must file form 9465-FS, "Installment Agreement Request," with IRS.

For tax liabilities greater than $50,000, IRS will also require the taxpayer to complete and file Form 433-F, "Collection Information Statement." This is a personal financial statement that will help IRS determine the installment payment amount. IRS will not require the taxpayer to make installment payments so large that the taxpayer would not be able to provide the necessities of life for his or her family. However, the rules are complex and a qualified tax advisor should be consulted when considering this option.

In order to be considered for an Installment Agreement, the taxpayer must be current on all other federal tax liabilities, including estimated tax payments for the current year. IRS will not allow a taxpayer to pay down one tax liability over time, while accruing another for another tax year. It is also important to note that interest and penalties do not stop accruing simply because an installment agreement is reached. These items will still add to the balance owed although their impact will dissipate over time as the liability is paid off.

Option #3 – The "Offer-In-Compromise"

For taxpayers in very poor financial conditions where payment of the tax liability will create a severe financial hardship, IRS will consider an "Offer-In-Compromise." This option allows the taxpayer to settle his or her liability for less than the full amount owed. This can be in the form of a one-time payment or a series of payments.

In order to be considered for this option, the taxpayer must file Form 656 "Offer-In-Compromise" and Form 433-A (OIC) "Collection Information Statement" or Form 433-B (OIC) for businesses. Like Form 433-F, the 433-A or B will provide IRS with a full financial picture of the taxpayer. IRS can then determine the taxpayer's ability to pay the tax balance due. Like the Installment Agreement, the taxpayer must be current on all other tax liabilities to qualify for this option. Also, the taxpayer must not be party to a bankruptcy proceeding. Generally, a taxpayer will not be considered for an "Offer-In-Compromise" if their total assets exceed the amount owed. It is not easy to qualify for this option, but if approved, the taxpayer must comply with the agreed upon arrangement.

Conclusion

This article discussed the methods to pay a federal tax liability that resulted from an audit. Option #1 is to simply write a check to IRS. This might be painful but it will resolve the matter quickly. Option #2, "The Installment Agreement," allows the taxpayer to pay the total liability and penalties over time but interest on the unpaid balance will continue to accrue until paid in full. Option #3, The "Offer-In-Compromise," can yield a settlement for an amount less than the actual tax liability. However, this option is available only to those who can prove severe financial hardship or insolvency. A taxpayer should consider each option carefully with the assistance of a qualified tax advisor in order to choose the most appropriate method.

IRS Relief For 403(b) Retirement Plans

Patterson Belknap Webb & Tyler LLP write: Recognizing that the requirement to have a detailed written plan document for a 403(b) retirement plan was a new and arduous task for many non-profit entities who sponsored such plans, the IRS has now published favorable guidance giving 403(b) retirement plan sponsors some much needed relief.

Background

Under new IRS regulations issued in 2007 (the "New Regulations") and subsequent IRS announcements, 403(b) retirement plans were required, no later than December 31, 2009, to have a written plan document in place that reflected the New Regulations. For many non-profits who sponsored such 403(b) retirement plans, this was a new and complex compliance requirement that required time intensive work by the non-profit and its retirement plan providers and other vendors. Some non-profits never before maintained formalized written plan documentation regarding their 403(b) retirement plans (and such documentation was generally not previously required by the IRS), while others had old documents that were not necessarily reflective of current law or current administration pertaining to the 403(b) retirement plan.

Subsequent to the December 31, 2009 written plan document requirement for 403(b) retirement plans, 403(b) plans, like many other defined contribution retirement plans (e.g., 401(k) plans), were required to be formally amended for certain legally required provisions by certain IRS-imposed deadlines. For example, for calendar year plans, amendments with respect to the Heroes Earnings and Assistance Relief Tax Act of 2008 ("HEART") were required to be adopted on or before December 31, 2010, and amendments relating to certain provisions of the Worker, Retiree and Employer Recovery Act of 2008 ("WRERA") were required to be adopted on or before December 31, 2011.¹ Additional legally required amendments are likely to be required in subsequent years.

Help for 403(b) Retirement Plans

Given the new requirements for 403(b) retirement plans in the last several years—i.e., to have had a formal written legally compliant plan document in place as of December 31, 2009 and to timely adopt post-2009 legally required amendments—the IRS has announced assistance for those plans that may not have met (or will fail to meet) such legal requirements.

1. Failure to Adopt a Compliant Written 403(b) Plan Document by December 31, 2009

The IRS has opened up its voluntary correction program (the "VCP")² to enable non-profit organizations that sponsor 403(b) retirement plans and that did not have a written plan document in place as of December 31, 2009 (or, if later, the date on which the 403(b) retirement plan became effective) that complied with the New Regulations to "fix" their noncompliance before the IRS otherwise becomes aware of such noncompliance. The VCP involves the plan sponsor completing and submitting an application to the IRS and paying a fee, which fee is likely to be significantly less than the penalties that could apply if the IRS were to otherwise find out about such noncompliance.

The IRS has given further relief for 403(b) retirement plans to incentivize prompt compliance by providing that if a plan sponsor files under the VCP on or before December 31, 2013 for failure to adopt a written plan document that complies with the New Regulations, then the fees for such VCP are reduced by 50%. The chart below shows the fees that would apply for this type of VCP filing:

2. Failure to Timely Adopt Legally Required Amendments After 2009

As mentioned above, 403(b) retirement plans were required to adopt certain legally required amendments since January 1, 2010 and may be required to adopt additional amendments in the near future. For 403(b) plans that either have not yet adopted such amendments or adopt them after the IRS-imposed deadline, the plan document can be considered compliant for these purposes if the following criteria is met:

a. A formal written plan document was in place as of December 31, 2009 that was intended to satisfy the requirements of the New Regulations or the employer failed to timely adopt such a plan document but corrects the failure under the VCP described above;

b. The post-2009 legally required amendments, when adopted, are made retroactive to the relevant legally required effective date;

c. The plan sponsor—when the IRS formally makes such options available—either:

i. Adopts a 403(b) retirement plan prototype document (i.e., a standardized plan document with an adoption agreement provided by a vendor) that has been pre-approved by the IRS. The availability of this option would seem to be at least another year away; or

ii. Applies for an individual determination letter from the IRS to document that its 403(b) retirement plan is in good order. The availability of this application process is anticipated to be several years away.

The date by which either (i) or (ii) must be done is technically referred to as the end of the plan's "remedial amendment period"; and

d. The post-2009 legally required amendments are adopted on or before the plan's remedial amendment period (described in (c) above), which, again, may be several years away.

With this relief, the IRS has made it relatively easy and accessible for plan sponsors to bring their 403(b) retirement plans into compliance and has given ample time to do so.³

3. Operational Noncompliance

While 403(b) retirement plans have been able to use IRS's correction programs for several years when failures arise from not following the plan's provisions (referred to as an "operational failure"), the new guidance gives expanded correction opportunities for 403(b) retirement plans and provides more specific methodologies for 403(b) retirement plans to correct these operational mistakes.

The IRS relief guidance is a welcomed event for 403(b) retirement plans that may be defective. 403(b) retirement plan sponsors are encouraged to consider whether corrections to their plans are advisable. If an updated formal written plan document was not in place by December 31, 2009, a plan sponsor should consider whether the 2013 reduced fee program can be used to correct this particular failure; if so, action will be needed by December 31, 2013 to take advantage of the reduced fee program.

Please contact one of the Patterson Belknap attorneys listed below if you would like more information on the IRS's relief program for 403(b) retirement plans.

Footnotes

^{1 The amendments pursuant to HEART pertain to changes in retirement plan rules for military personnel and their families. The amendments pursuant to WRERA referenced above pertain, among other things, to relief from 2009 required minimum distributions and the operation of a 403(b) plan with respect thereto.}

^{2 The IRS has also made its Audit Closing Agreement Program ("Audit CAP") available to correct this type of compliance problem. Under that program, if the failure is identified during an audit, the plan sponsor can correct the failure and pay a sanction.}

^{3 If all of the criteria for the special relief are not met, then it seems that a plan sponsor may still be able to fully correct for a failure to timely adopt amendments by submitting to the IRS's VCP (assuming it is otherwise eligible for the VCP) and paying a fee for a formal statement from the IRS that the plan has been appropriately corrected.}

Outlook For ESOPs In 2013

Steven M Burke for McLane writes: J. Michael Keeling, president of The ESOP Association, moderates a discussion on the outlook for ESOPs (Employee stock ownership plans) in 2013 between Greg Brown, a partner at Katten Muchin Rosenman LLP,  Steven M. Burke, director at McLane, Graf, Raulerson, & Middleton, and Ken Serwinski, CEO at Prairie Capital Advisors, Inc.

Keeling: What are the key advantages of using an ESOP structure? In the United States, will an altered tax environment affect these benefits?

Brown: The key advantages to an ESOP are tax advantages: the tax deferral for a selling shareholder and tax deductions for the employer for contributions to the ESOP to repay ESOP debt. In addition, where an ESOP owns all of the outstanding stock of the employer that has elected to be treated as an S Corporation, neither the ESOP nor the employer pays any federal income taxes. The cash flow enhancements to the employer often mean better loan terms for leveraged ESOPs. Other advantages include the possibility of enhanced employee productivity and the existence of a friendly market for the company owners who seek liquidity, diversification, controlled ownership succession, and so on. With the long-term capital gains rates effectively increased from 15 percent to 23.8 percent, the tax deferral for C Corporation ESOPs has become more attractive.

Burke: An ESOP is a powerful tool for rewarding and incentivising employees while at the same time creating liquidity for business owners. It enables employees to accumulate tax-deferred retirement benefits without requiring any employee contributions – unlike most IRA or 401(k) plans. As the shares in the ESOP appreciate, employees benefit from their contribution to the growth in the value of the company. At the same time, an ESOP creates a market for otherwise illiquid company shares. By using an ESOP, the company can bear the cost of buying out its owners – including through tax-advantaged borrowing – and, if it is a C Corporation, can deduct those costs. No such deduction is available to an S Corporation, but the portion of the corporation's earnings allocable to the ESOP is completely untaxed. Recent increases in US individual income tax rates have made these advantages even more impressive.

Serwinski: ESOPs are used to create liquidity events in part or in full for selling shareholders. They are used in situations where a company wishes to remain independent and allow itself to recapitalise in order to move ownership of shares to the next generation. In some cases, they are also used to create liquidity events for private equity firms where there is a question as to the investment's marketability. In all cases, there are advantages for the company, shareholders and employees that vary based on the company's tax status. In the case of C Corporation taxation, selling shareholders may enjoy a capital gains tax deferral if the ESOP acquired at least 30 percent of the outstanding stock. This deferral requires sellers to move the basis in their company stock to a portfolio of qualified US replacement securities within one year of the sale. The sponsoring company will be able to borrow money and repay the debt associated with ESOP, with pre-tax dollars rather than after-tax dollars as is the case with any other loan. Finally, the advantage to the employee is simple − no money to repay this loan comes from the employees. The company uses future cash flow and profits to repay the loan. The S Corporation shareholder sees some significant differences. There is no tax deferral available to these shareholders and they are taxed at current capital gains tax rates. The company and its employees enjoy the same benefits as the C Corporation but there is one significant advantage. The S Corporation ESOP company is tax exempt for its portion of taxable income. Therefore, a 100 percent S Corporation ESOP pays no taxes on income either at the federal or state level. This provides a distinct economic advantage by retaining all cash flow. In January 2013, tax rates increased related to capital gains with these rates increasing by 5 percent to 20 percent.

Keeling: What factors should companies consider before implementing an ESOP?

Burke: There are many factors to consider before implementing an ESOP, including cash flow – before and after the transaction, management succession, regulatory compliance, effect on existing contracts and loans, and effect on employee morale and corporate culture. For instance, if an ESOP uses leverage to purchase shares, the company should analyse its projected operational results to verify that it will have sufficient cash flow to meet operational needs and fund loan payments. Companies should also consider how an ESOP might change the relationship between the owners and the board of directors, since an ESOP is an owner who must act in a fiduciary capacity on behalf of the employees. Furthermore, the implementation of an ESOP requires compliance with regulatory matters that must be analysed early in the process. Lastly, a company should consider its workforce and determine whether an ESOP will achieve the intended goals of increasing moral and improving productivity.

Serwinski: The most critical consideration in implementing an ESOP is the honest evaluation of the company's operating model. Remember that, first and foremost, the company is going to create significant leverage that is non-productive in nature. The soundness of the operating model, therefore, needs to be in place. A critical portion of the analysis necessary to determine the feasibility of an ESOP is to understand the future working capital and capital expenditure needs over the next several years, and integrate that along with the cash flow demands of the ESOP. Certainly, in the case of the S Corporation, the tax-free status that the company will enjoy is critical in the analysis prepared for shareholders and their lending institutions.

Brown: We strongly recommend that companies have a feasibility study done before implementing an ESOP. Such a study will review historical financial performance and projections, the employee compensation base and financing prospects, the lending base, future repurchase obligations, corporate contingencies – lawsuits, environmental and tax issues – and the projected value of the company's stock. By reviewing all of these issues, the company, its owners, management and board will be in a position to make a reasoned and informed decision.

Keeling: To what extent are you seeing large corporations taking advantage of the ESOP structure of smaller family-owned businesses, as an exit strategy?

Serwinski: Though some larger companies have utilised an ESOP strategy, the bulk of transactions are smaller private companies that have values in the $20m to $100m range. Larger value companies tend to attract strategic purchasers due to a number of reasons including better capitalisation, management depth, diversified product/service offerings and a shareholder base less likely to want its culture and company to survive through the next generation. Recently, there has been an increase in smaller, thinly-traded public companies looking to create an alternative liquidity strategy. This is also true with other regulated businesses such as regional and community banks that have had significant shareholder liquidity issues since the last recession.

Brown: Over the last several years I have seen several large private companies turn to the ESOP structure as an exit strategy for its shareholders. The tax advantages are certainly a factor, but often keeping the company independent with the family name attached is at least as important. These companies are usually well capitalised and liquid, thus financing for the ESOP transaction is relatively easy.

Burke: While ESOPs are more common in smaller businesses, we do see some larger closely held corporations exploring ESOPs. Large corporations can realise significant tax advantages and provide employee incentives by using an ESOP. A selling shareholder of a C Corporation can defer US income taxation on certain sales proceeds, if they are reinvested in securities of US operating companies. A C corporation can also deduct reasonable dividends paid on ESOP-held stock and contributions to the ESOP up to 25 percent of covered payroll. Moreover, a large corporation that is considering growth via acquisition may find that having an ESOP as a shareholder provides it a tax advantage over other non-ESOP owned companies that could be bidding on the same targets, both in pricing for the transaction and its post-closing profitability.

Keeling: Has there been an increase of government enforcement with respect to ESOPs? Which areas and issues are in the spotlight?

Brown: During the last three years we have experienced increased enforcement activities by the US Department of Labor with respect to ESOPs. The key issue is valuation and whether the final projections used in completing the valuations are reasonable.

Burke: Yes, there has been an increase. The DOL has increased the frequency with which it reviews valuations establishing an ESOP's stock purchase price and the ESOP trustee's role in accepting the valuation. We believe this will be a continued focus of the DOL. Additionally, the Internal Revenue Service continues to audit ESOPs and their operations. Its focus is on ensuring that highly compensated employees do not benefit disproportionately from the ESOP. Under Internal Revenue Code Section 409(p), an ESOP established by an S Corporation must provide that no portion of the ESOP's assets can accrue for the benefit of a disqualified person during a non-allocation year. This section prevents excess accumulation of benefits to larger stockholders in an S Corporation that has an ESOP. Violation of Section 409(p) can be catastrophic for a company and its employees.

Serwinski: As ESOPs are qualified retirement plans, their oversight is performed by both the Internal Revenue Service and the US Department of Labor (DOL). Though both groups focus on a variety of issues, it is the DOL that has caused anxiety in their investigations (audits) of ESOP plans and their sponsors. Their focus tends to be on valuations and possible self-dealing at the point of the transaction. Though self-dealing is reprehensible on all levels, valuation issues have been more problematic. Their reviews occur subsequent to the closing of transaction with some occurring years later. Some investigations include companies that did transactions prior to the recession and, subsequently, suffered a drop in share price. These 'stock drop' cases allege that financial advisors to trustees should have known that the recession would adversely affect company performance and, therefore, overvalued the company. Needless to say, crystal balls are not provided to MBAs at graduation − if they were, homes would have been sold and 401ks would have been liquidated prior to the market collapse. It remains to be seen how this will be resolved, but this is a real issue at this time.

Keeling: What are the features of the sale of S and C Corporations to an ESOP?

Burke: The ESOP structure allows a C Corporation to use pre-tax dollars to fund the purchase of shares from selling shareholders. Additionally, a selling C Corporation shareholder can defer US federal income tax on shares sold to the ESOP if the ESOP ends up with at least 30 percent ownership in the company and the selling shareholder buys qualified replacement securities. Multiple selling shareholders can combine their sales in a single transaction to enable the ESOP to meet the 30 percent threshold. Although S Corporation shareholders cannot benefit from this deferred taxation, to the extent an ESOP owns an S Corporation, the Corporation's income will be exempt from US federal income taxes. Thus, both S and C Corporations can utilise ESOP ownership to manage tax liability.

Brown: Where the sale of an S Corporation to an ESOP is involved, we often see a combination of third-party and seller financing, so that the ESOP can achieve 100 percent ownership with the related tax efficiency. If the ESOP owns less than 100 percent, then the company will normally need to make distributions to the non-ESOP shareholders to enable them to make estimated tax payments but must also make distributions to the ESOP because of the one-class of stock requirement for S Corporations. Where C Corporation stock is being sold to an ESOP, normally the initial sale is designed to have the ESOP acquire at least 30 percent of the company's stock to allow the selling shareholders to elect to defer gain on the sale. The ESOP loan amortisation schedule is designed to balance the timing of contributions for tax deductions and to control repurchase liability.

Keeling: What regulatory and legislative developments do you anticipate in 2013?

Serwinski: As part of a comprehensive plan spearheaded by the DOL to tighten regulations on all retirement plans, ESOPs have been targeted in the area of private securities valuation and its impact on the transaction at the point of share purchase. The DOL has proposed regulations that would make financial advisory firms that provide trustees with valuations, fairness and adequate consideration opinions, fiduciaries. This is an aggressive position with no precedent. Trustees of ESOPs are charged with making the investment decision to acquire the shares of stock based on their due diligence, as well as opinions from their legal and financial advisors. The proposed regulations will be resubmitted for comments sometime in early summer 2013. It remains likely that the DOL will continue to seek this fiduciary change, but is unlikely to provide guidance as to how fiduciary responsibility will be split between financial advisor and trustee. It is also anticipated that serious discussions on tax reform will begin this spring. Any time tax reform has occurred in the past, retirement plans come under review and are at risk from changes that can create tax revenue.

Brown: We expect to see the US Department of Labor re-propose a regulation that would make ESOP appraisers, at least in some instances, fiduciaries subject to all of ERISA's fiduciary duty and liability provisions. We have already seen Congress increase the rate for long-term capital gains from 15 percent to 23.8 percent, thereby making tax-deferred sales to ESOPs more attractive.

Burke: The US Department of Labor (DOL) has recently filed several actions alleging failure by ESOP trustees to review valuation reports adequately in connection with sales of stock to ESOPs, allegedly causing the ESOPs to overpay for shares. We anticipate that the DOL will continue to focus its attention in this area. Additionally, the DOL continues its work on proposing regulations expanding the scope of people who qualify as fiduciaries for pension plans. Of particular importance to the ESOP community, the first draft of the proposed regulations included appraisers who provide valuation reports for ESOPs as fiduciaries. Despite determined opposition from the ESOP community and some members of the US Congress, and subsequent withdrawal of the draft proposed regulation, the DOL may still seek to expand the definition of fiduciary to include valuation experts. The issue remains unresolved.

Keeling: How have ESOPs been received in jurisdictions outside of the US? What specific challenges has adoption of ESOPs faced in these regions?

Brown: ESOPs, as conceived in the US, have been viable on a case-by-case basis in the UK and Ireland, but certainly are not universal. Extending a US-based ESOP to employees at foreign subsidiaries and affiliates can be very complicated, involving employer and employee tax issues, employment law, securities law and foreign exchange law issues. More likely to be established are programs such as a UK Share Incentive Plan or a UK Tax Favored Share Option Scheme.

Burke: Although ESOP-like structures are uncommon outside the US, non-US owners of businesses with operations in the US can attain the same benefits from an ESOP as a US business owner would. A non-US person cannot own stock in an S Corporation, but the tax advantages and employee relations benefits of establishing an ESOP for a C Corporation apply regardless of the nationality of the historical owners. Since non-US owners are typically less familiar with the ESOP structure, the challenge for advisors is to explain the benefits of ESOPs and dispel myths. For instance, many owners fear that selling to an ESOP will cause them to lose management control. In fact, historical owners can maintain control after sale to an ESOP by limiting the size of the stake held by the ESOP, using mechanisms like rights-of-first-refusal to repurchase shares, and limiting issues on which employees can vote their shares.

Serwinski: Under US law, employees working outside the country cannot be included in this retirement plan. Since many countries maintain their own pension schemes, US companies have established phantom share plans that mimic their ESOP. The plans, unlike the broad-based ownership plan in the US, can be discriminatory and are taxed at regular income tax rates upon a liquidity event. In the last few years, employee ownership plans have seen higher levels of interest in the UK, Canada and Australia. These plans do not carry the level of tax benefits that are available in the US.

Keeling: Do you except to see an increase in the use of ESOPs over the coming year? What factors might be set to influence this trend?

Burke: The leading edge of the baby boomer generation is transitioning from their working lives to retirement. This generational shift is going to involve a massive transition of wealth, and we expect that ESOPs will be a popular tool for financing the exits of historical owners. ESOPs will be attractive for two reasons. First, in a down market, strategic buyers may be difficult to find. An ESOP can provide an alternative market for the historical owners' shares. To the extent credit is difficult to obtain, shareholder loans can provide internal financing for an ESOP purchase. This is particularly important for many service-oriented businesses that lack hard assets. Second, many business owners value the culture they have created within their companies. The use of an ESOP allows them to transition ownership to people who share their history and values, thereby maintaining the established corporate culture.

Serwinski: The short answer is 'it depends'. History tells us business owner confidence, availability of financing, and successful operating performance will be the measures for continued ESOP implementations. The banks continue to seek loans and have become measurably more aggressive in seeking earning assets. However, the biggest barometer is the unknown of US economic growth. Should a prolonged recession in Europe and Asia continue through the second quarter, private company business owners may take their historical conservative views and hold back from entering into any ownership transition plans. Through the first two months of 2013, however, activity remains strong with the ESOP community believing that the year will mirror 2012, a successful year for new transactions.

Brown: Yes, we definitely expect to see expanded use of ESOPs during 2013. This is because many companies have deferred ownership succession issues over the past five years and now most companies have seen their value restored or increased since the Great Recession, and leveraged funds are available at favourable interest rates and terms. With the increase in long-term capital gains rates, the tax deferrals available on sales of stock to ESOPs have become more attractive.

Originally published in Financier Worldwide TalkingPoint, March 2013

What does DOMA mean for taxes? The Supreme Court will rule on two gay marriage cases this week, including the Defense of Marriage Act (DOMA). Although DOMA is not primarily a tax law, taxes are the basis for the case going to the Supreme Court

Roberton Williams for The Christian Science Monitor writes: The 1996 Defense of Marriage Act (DOMA) was not primarily a tax law but it certainly affects the federal taxes that same-sex couples pay. In fact, taxes are the basis for the second of the two cases concerning same-sex marriage that the Supreme Court will hear this week.

Although the federal government generally recognizes state laws concerning marriage, DOMA requires the federal tax code treat all same-sex couples as unmarried. That standard applies to both the estate tax and the income tax. While the Supreme Court will be reviewing an estate tax case, Windsor v. United States, its ruling will likely affect both taxes.
The estate tax issue is this: Under DOMA, same-sex couples cannot take advantage of the unlimited deduction for bequests to spouses or share the doubled exemption that benefits federally-defined married couples.

New Yorkers Thea Clara Spyer and Edith Windsor married in Toronto in 2007 because their home state didn’t allow same-sex marriage. New York did recognize their status when Thea died two years later, but the IRS didn’t. It denied Clara the estate tax’s spousal exemption, resulting in a tax bill of more than $360,000. Lower courts subsequently ruled that denial unconstitutional and the federal government has appealed. In an extra twist, the Justice Department is not arguing the appeal—the House of Representatives is making the case. 

The estate tax is small potatoes—in 2013 fewer than 4,000 estates will exceed the $5.25 million threshold for owing tax and few of those will involve same-sex couples. The income tax is where the action is: The Congressional Budget Office has estimated that hundreds of thousands of same-sex couples face different income tax bills because of DOMA.

The effect can be good or bad for a couple’s pocketbook. Marriage can reduce a couple’s income tax liability—yielding a “marriage bonus”—typically when spouses have markedly different incomes. Or marriage can increase their tax bill—a “marriage penalty”—usually when their incomes are similar. David Weiner and I explained all the details in a 1997 CBO paper.

But under DOMA, same-sex couples are not considered married and thus must file as individuals (or heads of household if they have dependents). They don’t suffer marriage penalties but neither can they benefit from marriage bonuses.

The IRS has made matters even more complicated. Under its regulations, same-sex couples in community property states that recognize their marriages, civil unions, or domestic partnerships must split their incomes (with some exceptions for income from assets owned separately). Each therefore pays income tax on half the total. The IRS rules create odd tax situations—I’ll explain some of those tomorrow.

The income-splitting requirement is based on a 1930 Supreme Court decision, Poe v. Seaborn, that affirmed income splitting for married couples in community property states (but not in non-community property states—see Lucas v. Earl). The result: The progressive rate structure of the federal income tax means income splitting combined with individual filing can only create marriage bonuses.

That’s the situation facing same-sex couples in three community property states, Washington (which recognizes same-sex marriage) and California and Nevada (which recognize domestic partnerships). If the court strikes down DOMA for tax purposes, many same-sex couples in those states will face higher tax bills. In other states that recognize same-sex relationships, couples may face bonuses or penalties. And in the many states that don’t recognize such relationships, nothing would change unless the court requires states to recognize same-sex marriages.

States that allow same-sex marriages, civil unions, or domestic partnerships for tax purposes could give people in those relationships the federal tax savings from income splitting even if the court upholds DOMA. They could use the same approach some non-community property states used right after World War II: establish community property rights for tax purposes only. After a number of states did exactly that, Congress created joint filing in 1948.

The Supreme Court will render such action moot if it strikes down DOMA. And if that happens, many same-sex couples will celebrate, even if it means that some will pay higher taxes.

Refining Cost Variables For Better Retirement Plans

Waldean Wall for FA-mag.com writes: Retirement income planning is a complex process with many moving parts and a lot of variables. Making educated assumptions is an important part of retirement planning, and if advisors get it wrong, the error can get compounded over decades.
Retirement planners are forced to forecast the future in a number of areas: 
• The return on retirement assets.
• The cost of medical care.
• Housing costs.
• The rate of inflation.
• Life expectancy.
• Income taxes.
• General cost of living.

Incorporating these assumptions into the process can be problematic because the rate of increase varies by spending categories. Yet, assuming one rate of increase is often standard practice when planning for retirement.
Perhaps a more effective approach would be to consider these expense variables individually. This can help us more accurately consider accumulation strategies and distribution strategies because our analysis may be better aligned with a realistic outcome.
Longer life expectancies, for example, increase the pressure on retirement assets. According to the U.S. Department of Health and Human Services, a 65-year-old in 1950 could be expected to live to an average age of 77 for males and 80 for females. In 2009, average lifespans for 65-year-olds had increased to 82 for males and 85 for females.
This increase in years spent in retirement means people need retirement income for a longer drawdown period. A longer drawdown period can also magnify mistakes in our assumptions. If we assume our income needs will increase at 3 percent a year while they actually increase at 3.5 percent per year, over 30 years the effect can be substantial.
To demonstrate, let’s take a separate look at three variables—general living expenses (assuming a flat 3% inflation rate), the cost of health care, and income taxes—and apply them to a husband and wife who are both 65 years old and hoping to retire within a year. Their only retirement income sources are Social Security and traditional IRAs.
Separating the general living expenses
As they look forward to retirement, the couple has made a number of estimates of future expenses:
• Housing - $12,000 per year.
• Medical expenses - $12,000 per year (this includes Social Security part B premiums, part D premiums, Medigap premiums, co-pays, dental, vision, etc.).
• General living expenses - $59,597.
• Income taxes - $11,140.
They expect to receive $30,000 per year from Social Security and $64,737 from IRAs.
It’s important to note that, according to a report by the Employee Benefit Research Institute (“Expenditure Patterns of Older Americans, 2001-2009,” by Sudipto Banerjee), some general living expenses, such as food, transportation, and entertainment, could decrease over time or increase at a slower rate than the general inflation assumption of 3 percent per year.
If general living expenses do grow at 3 percent, the cost would be $140,445 in 30 years. If they grow at 2 percent per year, the cost in 30 years would be $105,835. The chart below outlines what it take to fund these expenses.

If general living expenses increase 1 percent per year and their investment return is 7 percent per year, it will take $875,000. If these expenses increase at 3 percent per year and the retirement assets only grow at 3 percent, they would need $1.79 million—a difference of $915,000. This is a clear example of just how great the difference can be when assumptions vary over 30 years.
Separating health care expenses
Rising health care expenses remain a significant concern for retirees. Consider that health care costs have increased an average of 6 percent per year since 2002 (“Budgeting for Healthcare in Retirement,” by David Francis, U.S. News & World Report, May 23, 2012), which is more than twice the general rate of inflation. Add to that the fact that the annual cost of living increase in Social Security income benefits is only 1.7 percent for 2013 and you can see how important it is to carefully consider how heath care costs fit into your client’s larger retirement plan.
If your client requires little medical care and the increasing cost of this care is held in check, they may see somewhat controlled cost escalation. If, however, you have a client that needs more medical care and the costs in the overall medical system increase rapidly, they may have a different outcome.
For this scenario, we’ll assume our hypothetical couple will spend $12,000 a year on health care expenses at age 65. This includes premiums, co-pays, deductibles, and any other medical costs they might have. If their health care costs in retirement start at $12,000 a year and increase at 5 percent a year, the couple would end up paying $49,394 in 29 years. If the assumption is for health care costs to increase at 6 percent, they would end up paying $65,021 in 29 years. Finally, if we assume the health care costs increase at 3 percent per year, the annual cost in 29 years would be $28,279. The chart below outlines what it take to fund these expenses.


If the couple has a 3 percent increase in health care costs and their investments make 7 percent a year, it will take $219,000 to fund 30 years of retirement. Conversely, if their expenses increase at 6 percent a year and the retirement assets grow at 3 percent a year, they will need $563,000—a difference of $344,000.

Separating income taxes
Variances in income taxes may be the most misunderstood. Unlike some of the other expenses facing retirees, tax-rate adjustments ripple through clients' finances and have a compounding effect. Tax-rate increases escalate the need for more income to pay the increased taxes. This additional income results in more taxes and further accelerates the drawdown of retirement resources. Underestimated retirement costs can be magnified because of the additional tax that must be paid on additional IRA withdrawals.

Using the same hypothetical case study, the couple will pay $11,140 in federal and state income taxes in the first year of retirement. This means their income-tax rate in the first year of retirement is estimated at 11.76 percent. Let’s look at three different  scenarios to show the effects of tax rate increases and how an increase in living expenses can result in increased taxes.

The first scenario assumes that housing costs, health care costs and general living expenses each increase at 3 percent a year and that the tax rate does not increase. In this case, the couple will need $256,000 when they start retirement, growing at 5 percent per year, to pay those taxes.

In the next scenario, the rate of increase remains the same for housing, health care and general living expenses, but the tax rate increases at 1.5 percent per year. That relatively small yearly increase will mean the couple will need $325,000, growing at 5 percent per year, when they start retirement to cover those taxes—an additional $69,000.

In the final scenario, housing and general living expenses increase at 3 percent per year, but health care expenses increase at 6 percent a year and tax rates at 1.5 percent per year. Obviously, the couple will need more money to pay the increased medical expenses—$351,000 versus $256,000—but they will also need an additional $26,000 at retirement just to pay the additional taxes on the additional health care costs. This third scenario would require $377,000 when they start to cover their costs.

Next steps
Clearly, there can be significant differences when a flat rate of inflation is applied to retirement expenses versus the concept of separating the retirement variables. It’s our job as financial professionals to help our clients understand the importance of an ongoing tax assessment. Many people on occasion have situations that give them the opportunity to benefit from certain tax strategies. Some of these considerations include Roth IRA contributions and conversions, adjustments due to an anticipated tax bracket change in retirement, the 3.8-percent Medicare surtax and tax-deferred accumulation potential via a nonqualified annuity.

Another choice that can have a significant impact on retirement is failing to create a withdrawal strategy for retirement savings. You should review this with your client from the perspective of managing-the-tax-brackets and also noting potential issues with required minimum distributions from a portfolio. Encourage your clients to see their tax advisor for their personal situation.

Not thinking through the client’s specific situation can magnify the errors created when using flat increase assumptions in retirement. This is especially true for those retiring with modest living standards and those that are only marginally ready. Real rates of inflation can vary from age to age, family to family, and expense to expense. The further into retirement we go, the more impact inappropriate assumptions can have. It’s a good idea to fine tune our assumptions each year in order to reflect the most accurate projections possible.

Same-Sex Couples and Taxes

Roberton Williams for taxvox.taxpolicycenter.org writes: The 1996 Defense of Marriage Act (DOMA) was not primarily a tax law but it certainly affects the federal taxes that same-sex couples pay. In fact, taxes are the basis for the second of the two cases concerning same-sex marriage that the Supreme Court will hear this week.

Although the federal government generally recognizes state laws concerning marriage, DOMA requires the federal tax code treat all same-sex couples as unmarried. That standard applies to both the estate tax and the income tax. While the Supreme Court will be reviewing an estate tax case, Windsor v. United States, its ruling will likely affect both taxes.

The estate tax issue is this: Under DOMA, same-sex couples cannot take advantage of the unlimited deduction for bequests to spouses or share the doubled exemption that benefits federally-defined married couples.

New Yorkers Thea Clara Spyer and Edith Windsor married in Toronto in 2007 because their home state didn’t allow same-sex marriage. New York did recognize their status when Thea died two years later, but the IRS didn’t. It denied Clara the estate tax’s spousal exemption, resulting in a tax bill of more than $360,000. Lower courts subsequently ruled that denial unconstitutional and the federal government has appealed. In an extra twist, the Justice Department is not arguing the appeal—the House of Representatives is making the case.

The estate tax is small potatoes—in 2013 fewer than 4,000 estates will exceed the $5.25 million threshold for owing tax and few of those will involve same-sex couples. The income tax is where the action is: The Congressional Budget Office has estimated that hundreds of thousands of same-sex couples face different income tax bills because of DOMA.

The effect can be good or bad for a couple’s pocketbook. Marriage can reduce a couple’s income tax liability—yielding a “marriage bonus”—typically when spouses have markedly different incomes. Or marriage can increase their tax bill—a “marriage penalty”—usually when their incomes are similar. David Weiner and I explained all the details in a 1997 CBO paper.

But under DOMA, same-sex couples are not considered married and thus must file as individuals (or heads of household if they have dependents). They don’t suffer marriage penalties but neither can they benefit from marriage bonuses.

The IRS has made matters even more complicated. Under its regulations, same-sex couples in community property states that recognize their marriages, civil unions, or domestic partnerships must split their incomes (with some exceptions for income from assets owned separately). Each therefore pays income tax on half the total. The IRS rules create odd tax situations—I’ll explain some of those tomorrow.

The income-splitting requirement is based on a 1930 Supreme Court decision, Poe v. Seaborn, that affirmed income splitting for married couples in community property states (but not in non-community property states—see Lucas v. Earl). The result: The progressive rate structure of the federal income tax means income splitting combined with individual filing can only create marriage bonuses.

That’s the situation facing same-sex couples in three community property states, Washington (which recognizes same-sex marriage) and California and Nevada (which recognize domestic partnerships). If the court strikes down DOMA for tax purposes, many same-sex couples in those states will face higher tax bills. In other states that recognize same-sex relationships, couples may face bonuses or penalties. And in the many states that don’t recognize such relationships, nothing would change unless the court requires states to recognize same-sex marriages.

States that allow same-sex marriages, civil unions, or domestic partnerships for tax purposes could give people in those relationships the federal tax savings from income splitting even if the court upholds DOMA. They could use the same approach some non-community property states used right after World War II: establish community property rights for tax purposes only. After a number of states did exactly that, Congress created joint filing in 1948.

The Supreme Court will render such action moot if it strikes down DOMA. And if that happens, many same-sex couples will celebrate, even if it means that some will pay higher taxes.

Read our earlier on topic blog entry:

Love & Taxes : DOMA can have a major impact on same sex couples’ annual tax returns...

Steps you can take now to cut your 2012 tax bill / It's not too late to put money in an IRA, organize your records and make sure you're claiming all the deductions you can. But don't wait until April 15.

Kelley Holland for CNBC/MSN Money writes:  April 15 is right around the corner -- and that means the tax man cometh.  If you are among the millions of Americans who file tax returns later in the game -- perhaps you've been busy getting that root canal -- it's time to start looking for moves you can make to reduce your tax bill.

"Once December 31 comes and goes, there are not a lot of action items" to save on taxes, says Jackie Perlman, principal tax analyst at the Tax Institute at H&R Block. "But there are some things to consider."


For starters, take a look at your retirement accounts. If you are an employee, IRS rules allow you to put away $17,000 per year in a 401k account for 2012 at any time up to April 15. (If you're over age 50, you can increase that amount to $22,500.) As soon as you put money in that account, any gains are tax deferred, and the contribution comes off your income for the year. You can also put away money in your individual retirement account.

Self-employed workers can cut their tax bills using SEP retirement accounts. "You get a current tax deduction and save for your retirement," says Mackey McNeill, a CPA and personal finance specialist who is also president and CEO of Mackey Advisors Wealth Advocates.
McNeill says she tells self-employed clients to put away at least 30% of their gross income so they can fund things like retirement accounts. Not saving regularly "is the number one reason people don't take advantage of their tax deductions," she says.

For taxpayers with eligible high-deductible health plans, contributions to a health savings account, or HSA, are another last-minute option. For 2012, it's possible to put in as much as $6,250 for a family plan and $3,100 for an individual.


When "the money goes in, you get a tax deduction for it," says McNeill. "If you use it for health expenses later, it's never taxable to you at all. The money can grow the same as in a 401k, or you can treat it as a money-market slush fund for health care expenses," she says.

Casualty losses are another opportunity for reducing your tax bill. If you suffered losses from Hurricane Sandy -- or any loss in a federal disaster area -- you can claim that on either your 2012 or your 2011 return. Only you know which year will net you more savings. This year the IRS is giving you until Oct. 15 to figure it out, even if you don't file an extension on your 2012 taxes.

McNeill points out that parents who are unmarried or divorced may be able to benefit from careful attention to their child deduction. "Sometimes people just assume one person is going to take the child deduction," she says. But the higher earner will actually receive less of a tax break from the deduction than the low-income spouse. If the plan is to share the savings equally, she says, "be really careful and run the numbers both ways."


Whatever your tax circumstances, financial advisers suggest you stay organized. If your idea of record keeping consists of stashing receipts in a paper bag all year and hoping for the best in tax season, you'll likely miss opportunities for savings. Many attractive deductions only become apparent when you sort through your records, according Perlman. "If you're doing your return on April 15 at three in the afternoon, that's a lot harder," she says.

Perlman says that if you go through your records and tally up your deductions, you may find that itemizing is a better bet than taking the standard deduction, even if you don't pay property taxes or mortgage interest. "You need to test it," she says. "If you're paying a lot of state taxes, it can put you over the standard deduction." So can significant charitable contributions, for that matter.

In addition to finding tax savings, you may be able to save on taxes by avoiding what Perlman calls "a huge tax mess." If you turned 70.5 years old in 2012, you are required to take your first minimum distribution from your retirement account by April 1. If you don't, she says, the penalties are steep.

Even for accountants, tax season is no fun. But with a little planning and attention to detail, it can be a lot less painful.