A VAT Tax?

A recent Boone County Journal editorial considered replacing the personal income tax with a 17%, flat-rate, Value Added Tax (VAT). According to the editorial, the major advantage would be to spare Americans the need to file a tax return. The editorial suggested that the tax regime would be similar to taxes in place in Canada and Australia.

VAT is essentially a national sales tax. Such a tax would not help most people in Boone County.

1. Starting up a national sales tax by itself will not eliminate tax returns. Canada and Australia both have a Goods and Services Tax (GST) that is a VAT. In Canada, it's extremely unpopular, and often called the "Gouge and Screw Tax." It even applies to postage stamps. Provincial sales taxes are also collected in Canada.

Both countries still have income taxes that are just as high as the US. Canadians "file" and Australians "lodge" tax forms that are every bit as complicated as Form 1040. This in addition to sales tax and GST in the 10-15% range.

How the tax system is structured is what determines whether a complicated tax return must be filed. The United Kingdom has both a VAT and an income tax. But, because of the way the UK system is designed, many Britons do not have to complete a tax return. New Zealand works similarly.

2. Most Americans pay federal income taxes of less than 17%. But they also pay an additional social security tax of just over 15% of their wages.

Social security taxes are cleverly disguised. Unless you are self employed, they don't show up on Form 1040: On your paycheck, you'll see a deduction, sometimes labeled "FICA." Double that amount is paid in social security taxes on your wages.

Most people also pay state income taxes and state sales taxes. Remember, none of those taxes would go away if the federal income tax was replaced with a 17% national sales tax.

For most people, it would be a significant tax increase.

3. In most states and the federal system, it's rightly assumed that the well-off can pay a bigger percentage of their incomes than those with more modest means. Yet a flat tax (whether income or VAT) is often called a "fair" tax, because everybody pays the same rate. This presumes that Fred Factoryworker, with a family to support, can just as easily and should pay the same 17% of his income as Milton Millionaire.

4. To see just how "fair" a flat-tax system is, look no further than Illinois.

Millionaires in Lake Forest, Illinois have one of the lowest tax state income tax rates in the US. Just 3.75%. But a poor, struggling family in Belvidere pays that same rate, too. If you're trying to support a child on $20,000 per year, a 3.75% state income tax rate doesn't help. Nor does a sales tax of 10.25% on diapers in Chicago.

Illinois' flat income tax is embedded in its Constitution. Large Illinois corporations get a break because the Constitution caps the corporate tax rate as a function of the flat, personal income tax rate. Then factor in a "flat-rate" toll for every car on Northern Illinois expressways, and a flat-rate license plate fee (Late-model BMW owners pay the same as a 1999 Chevy).

With our flat, "fair" taxes, despite having one of the highest tax burdens in the US for the poor and middle class, Illinois is flat broke!

5. VAT is ultimately paid by consumers. A VAT in the US would not affect the bottom line of a corporation considering a move overseas. For a VAT to influence that decision, we would have to give a corporate tax break and ask working families to pay more of the burden (either as VAT or income tax). There are better ways to stop basis and income shifting to tax haven countries than giving into the demands of greedy companies that don't want to pay their fair share.

The income tax is too complicated. Lobbyists and others have contributed millions to politicians to keep the current system in place. The tax should be simpler, as well as fairer.

The solution is real reform, not gimmicks like VAT or flat-rate taxes.

Isn't sales tax on Internet services against federal law?

Generally it is, and has been for many years. Recently Congress made the law prohibiting a sales tax on Internet service permanent. A few states had a sales tax (including Wisconsin) on Internet services that were exempt from the ban because these taxes were already in place when the ban took effect. These exemptions will be phased out soon (unless Congress decides to renew them and let those states continue to charge).

Has the deductible IRA and Roth Contribution Limit been increased for 2016?

No, same amount as last year. You can contribute $5,500 to a deductible IRA or a Roth IRA for 2015 and 2016. But if you are at least 50, you can contribute an additional $1,000 per year as a catch-up contribution. So, if you are over 49, you can contribute $6,500 for each year.

Generally, contributions must be made by the tax filing deadline. That means you have until April 18, 2016 to make your 2015 contribution. For example, on March 1st, 2016, you could contribute $10,000: $5,000 for 2015 and $5,000 for 2016.

Your IRA or Roth contribution is also limited by the amount of compensation income you earned. If you only made $2,000 last year, you could only contribute $2,000 for that year. And for higher income filers, if you are covered by your employer's retirement plan, you may not be able to deduct your IRA contribution.

If you are of modest means, don't forget there is an up-to-$1,000 retirement savings credit available. This comes directly off your tax bill and makes it easier to save. It applies if your single adjusted gross income is under $30,000, $45,000 if you are a head of household, or $60,000 if you are married filing jointly.

Retirement accounts represent an excellent planning opportunity to lower your tax bite either currently or over time. But remember, there are a number of important rules dealing with IRAs and Roth IRAs. And you can lose money if you do not invest wisely. This discussion only deals with the contribution limit. Be sure you are well-advised on the rules relating to retirement accounts and have the right plan before taking the plunge.

If death tax no longer applies, can I just write my own will?

Until this year, multiyear estate planning has been a major headache for both lawyers and their clients. Even the best lawyer can’t write someone’s will in November when nobody has any idea what the law will be in January! Congress’ passing the American Taxpayer Relief Act of 2012 at the beginning of the year was just that: Relief.

For at least the last two decades, estate tax laws have been constantly changing and subject to “temporary” tax provisions. Even though estate planning is forward-looking, there has been no way to accurately predict what the tax law would be next year, let alone when the maker of the will actually passed away!

For many people of comfortable means, this has meant an annual (and often expensive) trip to their lawyer’s office to prepare unintelligibly complicated estate documents to try to reduce the potential tax bite.

This law has finally brought some certainty to the estate tax laws: In short, for taxpayers worth less than $5 million (and married couples worth under $10 million), the estate tax is a thing of the past. Gone, too, are most of the complicated gyrations married couples had to go through to take advantage of both spouses’ exemptions. Good riddance.

Even better news. Many states with inheritance taxes are phasing them out or have eliminated them completely. Taxpayers in Indiana no longer have to worry and Tennesseans are about to join them! In Illinois, beginning this year, only estates over $4 million are subject to state death taxes.

The results of these federal and state tax simplifications and phaseouts should be incredibly positive. Estate planning should be a lot simpler for most people. The all-too-frequent, tax-driven professional reviews of these plans will come to an end. Without having to consider estate or inheritance tax, probate proceedings should also be simpler and cheaper.

But does this mean you should treat estate planning as a do-it-yourself project?

You are free to write your own will, and many have done so successfully.

Many lawyers do not make money writing wills. In fact many “lose money” and don’t cover their overhead for the time spent. Often, they provide simple estate planning as a service to their clients.

Before you decide to buy will software and go it alone, there are several things you should consider:

Effective estate planning also includes providing for your minor children. Who should rear them if both parents die? Should their guardian have access to the purse strings? If you become disabled and your spouse can’t act, who should make decisions about your welfare? What if there’s a dispute among the family?

What if your spouse remarries? Do your children get “cut out” in favor of the new person’s kids?

How about your IRA and life insurance? Are the beneficiaries up to date? Should you roll over the IRA now to a Roth IRA and avoid a nasty tax problem? Either way, did you choose a beneficiary that would minimize the income tax consequences? (And you thought the tax problems were gone.)

Many do-it-yourself wills (and trusts) have survived the probate process, but have been delayed or subjected to additional legal procedures because their makers didn’t follow certain formalities or weren’t aware of the consequences of those “helpful” terms and phrases they thought “would be a good idea” to include. Remember, you won’t be around to explain what you meant to say.

Any amount these do-it-yourselfers saved by not consulting an attorney was more than consumed by additional probate costs. The law reporters are full of examples of probate cases that “saved” a few hundred dollars and wasted thousands of dollars. (And those are just the cases that went up to the appellate courts!)

An estate can easily be whittled away to nothing if it comes in dispute.

Estate planning remains important. While the estate tax may be gone, the probate process isn’t. The same important considerations apply. You’ve worked a lifetime to accumulate your possessions and you should invest a few dollars in making sure your legacy isn’t wasted.

Can I still get a tax break for insulating my house?

Yes, provided that you hurry. The applicable tax credit expires on December 31, 2013.

It’s difficult in the summer to visualize three feet of snow on the lawn, a slippery sidewalk and a drafty threshold, but in just a few months, they will all be back. It’s much easier to fix your home now instead of when the cold wind is howling. And the year you make home improvements is the year that you’ll reduce your heating bill.

There are three energy credits of interest to homeowners. The first is known as “Qualified Energy Efficiency Improvements” and covers insulation, roofs and windows in existing homes.

The second is “Residential Energy Property Expenditures.” This program covers furnaces, air conditioners, electric heat pumps, water heaters, biomass (wood) fueled stoves and advanced main air-circulating fans in existing homes. Both of these first two programs expire at the end of 2013.

The third program is for “Residential Energy Efficient Property.” This credit is for solar, fuel cell, small wind, and geothermal systems. It expires at the end of 2016.

Let’s first focus on the first two programs. You can take a credit of up to 10 percent of the purchase price paid for these improvements, up to a total cost of $5000 (for a total credit of $500). That’s a maximum for the lifetime of the program. If you’ve taken any of these credits since 2005, you’ll need to subtract the credit(s) you already took from this year’s maximum credit.

Only $200 of this credit can be used for replacement windows.

Specific standards dictate what materials or systems qualify. They must meet the standards set by the 2009 International Energy Conservation Code or, if applicable, Energy Star requirements. For example, a metal roof must have pigmented coatings and asphalt roofs require cooling granules designed to reduce heat gain.

The manufacturer should provide information on whether their products qualify. When in doubt, demand proof that the materials qualify for the credit before you buy. Check the packaging and the manufacturer’s website.

Finally, the third program is a more generous 30 percent credit of the cost of installing solar, small wind, fuel cells, or geothermal systems. This third credit can be used in new as well as existing homes. If you are considering building a new home or a major upgrade, this credit might be of interest to you.

Even with the credit, it may still be more expensive in today’s energy market to invest in these systems. But as energy prices rise, the cost gap may very well narrow. There is also the satisfaction of having taken a positive step toward a better environment.

To claim any of these credits, attach Form 5695, Residential Energy Credits to your return. You should keep the certification or Energy Star label with your tax records, but don’t attach them to your tax return.

Everyone agrees that conserving energy saves money, reduces pollution and is the right thing to do. Yet Congress has passed tax breaks for saving energy several times only to let them expire, and then reinstated them several times. The latest reinstatement came in the extenders bill (American Taxpayer Relief Act of 2012) passed at the beginning of the year.

It remains to be seen if these energy credits will be extended further. Most of the other “temporary” tax breaks in the tax code were made permanent or extended for longer periods this time. The current crop of tax credits is also not as generous as prior versions. A 10 percent tax credit barely covers the sales tax paid on these items.

Fortunately, there are no income limits on using any of these credits. And even if you don’t itemize your deductions, you can still take advantage of them. These credits apply to your main residence and include mobile homes, cooperatives and condominiums. If you live in a duplex and both families chip in for new insulation, each of you can take up to the maximum credit for your share. But you may not use them to improve a rental property or your vacation home.

I thought the “fiscal cliff” only applied to the tax rates after January 1. But the IRS says that I can’t file my 2012 return until at least January 30 and refunds will come even later? Why is my 2012 refund being delayed?

The majority of taxpayers will be able to file starting on January 30. But taxpayers who must file certain forms or schedules will have to wait until mid-February or early March before the IRS will be able to process these returns. These forms include a lot of the business-oriented tax credits. But several of the tardy forms affect mainly individuals, including energy-efficient home credits and qualified adoption expenses.

There are several reasons why the fiscal cliff delayed the tax filing season. A major reason was that not all of the tax provisions that are affected expired on December 31, 2012. Many of them had already expired at the end of 2011.

As a result, these expired provisions affect 2012 tax liabilities for a lot of people. Many tax experts assumed that Congress would extend these provisions retroactively (as they have done in the past). Still, there was a lot of uncertainty, particularly as the end of the year approached.

The IRS is required by law to collect and program their systems on the basis of the law as it is currently in effect. So it can’t legally begin changing its systems to reflect tax changes until the proposals become law. As a result, the IRS was unable to start reprogramming its computers, revise forms, or make other necessary changes until President Obama signed the new tax law on January 2.

These already-expired breaks included relief from the Alternative Minimum Tax, which would have caused many middle class taxpayers to pay significantly higher taxes in 2012. The new tax law extended the relief that had been given in 2011 and earlier years to 2012. In this latest legislation though, that relief has been made permanent. The amount of the relief is also being indexed in future years to account for inflation.

Other retroactively-extended breaks allow teachers to deduct $250 for classroom expenses, reauthorize deductions for residential energy efficiency improvements, and provide the ability to give away IRA proceeds tax-free to charity. They also allow taxpayers to deduct college tuition and many other provisions, including the popular research tax credit for businesses.

For the last several years, American financial planning has been in a shambles because of the uncertainty of the tax laws. Every year, Congress has waited until the last minute to extend popular tax breaks. In some cases, like this year, they waited until beyond the last minute.

Many economists believe that the economy and financial markets suffer when taxes are uncertain. Not knowing what tax rates are going to be next week or even what the current tax law will end up being is unsettling to anyone trying to prepare a budget.

The new law brings some good news. Some of these tax breaks that have been regularly extended on a year-to-year basis have now been made permanent. In addition, the new tax brackets are permanent.

Of course, even “permanent” tax laws evolve, and are always subject to change. But at least now we have fewer provisions that automatically expire on some future date. This brings more certainty in the short and medium term.

There are many provisions of the new tax law will affect the amount of tax you’ll pay. I will have a lot more to say about the provisions of the American Tax Relief Act of 2012 in future columns.

Does this mean the April 15 (and March 15 corporate) filing deadlines will be extended?

So far, the government has made no moves to change the tax deadline. Of course, taxpayers can always request filing extensions.

My best guess is that the tax filing season will be compressed, but will end on schedule in mid-April.

Remember, even if you file for an extension, you still have to pay your taxes by the deadline or you’ll be charged interest and penalties.