Author: dsauder

“Remember that happiness is a way of travel, not a destination.”

2021 IRS Business Tax Expensing for Auto Mileage

For tax purposes businesses generally can deduct the entire cost of operating a vehicle when following tax rules guidance. Alternatively, they can use the business standard mileage rate, subject to some exceptions in the tax code. The mileage deduction is calculated by multiplying the standard mileage rate by the number of business miles traveled. Self-employed individuals also may use the standard rate, as can employees whose employers do not reimburse, or only partially reimburse, them for business miles driven.

Many taxpayers use the IRS business standard mileage rate to help simplify their recordkeeping. Using the IRS business standard mileage rate takes the place of deducting almost all of the costs of your auto. The IRS business standard mileage rate takes into account auto costs such as maintenance and repairs, gas and oil, depreciation, insurance, and license and registration fees.

Beginning on January 1, 2021, the IRS standard mileage rates for the use of an auto (also vans, pickups or panel trucks) is:

• • • • • 56 cents per mile for business miles driven, down from 57.5 cents for 2020

• • • • • 16 cents per mile driven for medical or moving purposes, down from 17 cents for 2020

• • • • • 14 cents per mile driven in service of charitable organizations, no change from 2020

Mileage related to unreimbursed business expenses and moving expenses are limited to certain taxpayers as a result of the Tax Cuts and Jobs Act for tax years 2018 through 2025:

Business expenses:

• • • • • • • Unreimbursed business expenses subject to a 2% floor as an itemized deduction have been eliminated.

• • • • • • • Eligible taxpayers for business mileage expenses:

• • • • • State and local government officials paid on a fee basis, and certain performing artist

The IRS standard mileage rate for business is based on an annual study of the fixed and variable costs of operating an automobile. The IRS rate for medical and moving purposes is based on the variable costs from analysis.

Taxpayers may have the option of calculating the IRS actual costs of using their autos rather than using the IRS standard mileage rates. If instead of using the IRS standard mileage rate you use the IRS actual expense method to calculate your vehicle deduction for qualifying business miles driven, you must maintain very careful records of qualifying expenses. When using this IRS method, it is vital to keep track of the IRS actual costs during the year to calculate your deductible vehicle expenses. One of the most important tools is a mileage logbook. Business with auto fleets must apply actual costs for mileage expenses.

If you have additional questions on 2021 IRS business tax expensing for auto mileage, please contact our office.

Preface: Opportunity is missed by most people because it is dressed in overalls and looks like work. — Thomas A. Edison (one of the most influential inventors of all time.)

Employer Tax Credits for Paid Family and Medical Time-Off

Tax legislation with The Consolidated Appropriations Act, 2021 extends the employer credit for paid family and medical time-off through December 31, 2025.

Under unique provisions of the Consolidated Appropriations Act, 2021, the credit for coronavirus related paid sick and family time-off, originally part of the Families First Coronavirus Response Act, was extended through March 31, 2021. The Families First Coronavirus Response Act (Act) provided paid sick leave and expands family and medical time-off for COVID-19 related reasons and creates the refundable paid sick time-off credit and the paid childcare leave credit for eligible employers.

Extended Employer Credit for Paid Family and Medical Leave

Employers who provide paid family and medical time-off to their employees may claim a tax credit which is equal to a percentage of wages they pay to qualifying employees while on family and medical time-off. The credit is effective for wages paid in tax years beginning after December 31, 2017 through December 31, 2025.

With the passage of this legislation employers must have a written policy in place that meets certain requirements, including providing:

• • • • At least two weeks of paid family and medical time-off (annually) to all qualifying employees who work full time (prorated for employees who work part time), and
      • The qualifying paid time-off is not less than 50 percent of the wages normally paid to the employee.

A qualifying employee is any employee under the Fair Labor Standards Act who has been employed by the employer for one year or more and who, for the preceding year, had compensation of not more than a certain amount.

Family and medical time-off for purposes of the employers who want to claim the credit include:

• • • • Birth of an employee’s child and to care for the child.
      • Placement of a child with the employee for adoption or foster care.
      • To care for the employee’s spouse, child, or parent who has a serious health condition.
      • A serious health condition that makes the employee unable to perform the functions of his or her position.
      • Any qualifying exigency due to an employee’s spouse, child, or parent being on covered active duty (or having been notified of an impending call or order to covered active duty) in the Armed Forces.
      • To care for a service member who is the employee’s spouse, child, parent, or next of kin.

The credit is a percentage of the amount of wages paid to a qualifying employee while on family and medical time-off for up to 12 weeks per tax year.  The minimum percentage is 12.5% and is increased by 0.25% for each percentage point by which the amount paid to a qualifying employee exceeds 50% of the employee’s wages, with a maximum of 25%.  In certain cases, an additional limit may apply.

An employer must reduce its deduction for wages or salaries paid or incurred by the amount determined as a credit.  Also, any earned wages taken into account in determining any other general business credit may not be used in determining this credit.

If you have any questions about qualifying for the tax benefits of this credit, please call our office.

Preface: The kiddie tax is a tax imposed on individuals under a certain age (under 19 years old, and full-time students age 19-23 years old), whose investment and unearned income is higher than an annually determined threshold.

Taxpayer Planning for the Kiddie Tax

Taxpayers claiming dependents who have unearned income during the year might want to consider some year-end tax planning strategies to reduce their overall tax burden. In addition, due to recent changes in the tax law, they may also have an opportunity to amend a prior year return.

The Tax Cuts and Jobs Act (TCJA) modified the “kiddie tax” to use the ordinary and capital gains rates applicable to trusts and estates to the net unearned income of a child after 2017.

However, the Further Consolidated Appropriations Act, 2020 enacted in 2019, reverts the kiddie tax to the prior use of the parents’ tax rate for tax years beginning after 2019. Therefore, for tax years beginning in 2020, the kiddie tax is calculated using the pre-TCJA rules where a child’s unearned income is taxed at the parent’s marginal tax rate. The Further Consolidated Appropriations Act also allows a taxpayer to retroactively apply the pre-TCJA rules to 2018, 2019, or both.

In general, a child is subject to the kiddie tax if:

• • • the child is required to file a tax return and he or she does not file a joint return for the year;
    • the child’s unearned or investment income is more than a threshold amount ($2,200 for 2019, 2020 and 2021);
    • either parent of the child is alive at the end of the year; and the child is:
      • • • • under age 18 at the end of the tax year;
            • age 18 at the end of the tax year and does not provide more than one-half of his or her own support with earned income; or
            • at least age 19 and under age 24 at the end of the tax year, a full-time student, and does not provide more than one-half of his or her own support with earned income.

Under the rules prior to TCJA, the child’s tax liability is equal to the greater of:

1. 1. 1. The tax on all of the child’s income without regard to the rules for the kiddie tax; or;
      2. The sum of the tax on the child’s total income reduced by net unearned income, plus the child’s share of the allocable parent tax.

In some cases, a parent may elect to report a child’s income on the parent’s return. If a parent makes this election, the child is not required to file a return. If a parent makes the election to report a child’s unearned income on the parent’s return, that income is treated as the parent’s investment income for purposes of figuring the investment interest expense deduction. However, the parent may not claim an itemized deduction for the child’s investment expenses.

Moreover, there are other tax deductions that the parent may not take that the child could have taken on the child’s return. These include the standard deduction for a disabled child, the deduction for a penalty on early withdrawal of the child’s savings, and the itemized deduction for the child’s charitable contributions.

It is important to review all the facts and circumstances of your situation in order to determine whether you should use the TCJA or the non-TCJA kiddie tax rules to amend your 2018 and 2019 tax returns to secure potential refunds. You might also consider if there is a benefit to reporting your child’s income on your tax return.

Preface: Each payroll provider should be able to articulate how their company has developed a niche in the payroll industry, and this can help you understand how well each company will be able to serve you.

How to Choose the Right Payroll Provider

Credit: Matthew P. Glick

Payroll processing is one of those crucial back-office operations that every business needs, but few people fully understand. HR laws are complex, and are continually evolving. Processing payroll can easily feel like a process that is just beyond your control, where you press buttons, and employees get paid. In this article, we will be breaking down what it is that you should look for in a payroll provider by classifying three phases (Evaluating what you need, Searching the market for available solutions, and RE-searching the list of available solutions by comparing each contender with the competition).

1. Evaluating

In this phase, you will mainly be concerned with evaluating your current needs. A good starting point would be understanding why you are looking into switching providers. By identifying the “pain points” with your current provider, you should be able to more easily identify a solution that will satisfy your needs much better. For instance, if customer service regularly fails to deliver on expectations, consider locating a provider that has a dedicated team or account manager to handle customer service, instead of a call center.

Some other points to consider would be the complexity of your payroll situation. What kind of benefits do you offer employees? Always be sure they are prepared to handle anything unique you bring to the table. The more complex your situation, the less willing you sould be to compromise on having a knowledgeable onboarding team that will be able to configure your solution just the way you need it. Some companies with a higher employee turnover may find it beneficial to invest in an integrated HCM module, which would allow them to process onboarding paperwork online, eliminating the need for paper forms.

Remember to look into what kind of integrations you will need. Making sure that your payroll provider integrates with your accounting software can save valuable time. Another integration that may save time depending on the size of your company would be timesheets automatically importing into your payroll system.

Don’t forget to evaluate you company’s future growth plans as well. Identifying a solution that has room to grow with your company will save you much time and hassle, and will allow you to focus on those growth plans rather than medicating the growing pains in HR.

Note: If your company has relatively few needs with minimal complexity, an option to consider would be Quickbooks Payroll (especially if you already use them for accounting). Their pricing structures are pretty transparent, and their online version even offers an automatic payroll option for salaried employees, or hourly employees who regularly work the same number of hours.

2. Searching

In this phase of the journey to finding the perfect payroll provider you will want to focus on searching the market for what is available. Use the list of needs that you came up with in the previous phase to quickly “weed out” any obvious misfits. Use that list to keep focused as you browse each company’s carefully curated public image. It’s easy to get taken in by all the bells and whistles that a solution offers, but keep in mind that a great solution that may not have all the bells and whistles is far better than one that looks shiny but repeatedly fails to deliver. Staying objective is the key here.

Tip: Avoid filling out forms that ask for contact information at this stage. You’re just trying to get a high-level overview of each company, and once you get on their marketing lists, it can be very difficult to get off. In order to get pricing data, you will most likely need to contact the company, but avoid doing so until you have identified a few clear front-runners.

3. RE-searching

By the time you get to the end of this phase, you should have a clear idea of which direction you are headed. This is the part where you will want to meticulously compare each company with the competition. Remember, this company will be handling sensitive payroll information, and will be the conduit through which your largest expense sources flow. No pressure, but don’t mess this one up!

Develop a list of questions to ask each company. A few examples would be: “What sets your company apart from the competition?” or “How has your company fared during the COVID-19 pandemic?” Each company should be able to articulate how their company has developed a niche in the payroll industry, and this can help you understand how well each company will be able to serve you. As of the date of this publication, the pandemic is nearly two years old, but the second question should serve you well in identifying a company that is able to adapt to change quickly, which is crucial for any payroll company.

You will also want to scour reviews. Websites like G2 and Capterra are great for this. They will even find the most helpful critical reviews for you, so you can get a balanced perspective on the best and worst parts about a company.

In the end, the company that is perfect for you may not be perfect for the next person, which can make this search a little more complex than we would like, but keeping your company’s goals in mind can go a long way in finding the right solution for you.

This article is general in nature, and it does not contain legal advice.  Contact your advisors to discuss your specific situation.

Preface: When inventory costs catapult, a business owner may find himself in the strange position of making higher profits but having less cash.

Catapulting Costs

Credit: Jacob M. Dietz, CPA

Catapult on the Job Site

Imagine Abner’s hammer crash into another nail as he fastens another 2X4 to connect another truss on another building.  Abner is simply doing his honest work. He has done this for years.  His father started the business, and he has been building even longer than Abner.  The gentle breeze blows across his sweated face and tugs at his hat.

Now, imagine someone installing a small catapult in the middle of the building that is being constructed.   Abner and his dad stare in disbelief at the catapult.  Neither of them has ever seen a catapult come to a job site before.  The catapult flings a stone up through the trusses.  The stone sails mere inches away from Abner’s hat on the way up, and it almost hits Abner’s dad as it descends. The stone could hurt Abner on the way up as the catapult propels it away from the earth, and it could hurt Abner or his dad on the way down as gravity hurls it towards the ground.

Business owners might stress if catapults started flinging stones at their builders, but fortunately I have not heard of any construction companies coming under catapult attack.  Some companies, however, have been threatened by catapulting costs.  Some fluctuations in costs may be a normal part of business, but unfortunately some costs have fluctuated in recent times in ways that current business owners, and perhaps their fathers too, have never experienced.  Although the business owners might desire to be able to simply work a normal day without catapulting costs, unfortunately the catapult has come to the industry.  How do catapulting costs threaten businesses?

Increasing Costs

First, catapulting costs could hammer a company’s bottom line if the company cannot raise prices enough to compensate for their increased costs.  Imagine Abner’s building company normally pays $35 in lumber for every $100 of sales.  That left them with $65 for every $100 in sales to pay labor, subcontractors, and other expenditures and still have some left over for a profit.  Net profits vary from business to business and industry to industry, although for this example we will assume that the company normally kept $15 of profit for every $100 of sales.  If the cost of lumber suddenly doubles on the company, and they failed to raise their prices or make any other adjustments, then lumber would cost them $70 for every $100 in sales.  Instead of making $15 on every $100 of sales, they would lose $20 on every $100 of sales.  The catapulting prices hit this hypothetical company on the way up.

Now suppose the company realized that lumber was shooting up, and they adjusted their prices to make the same profit.  Now they should not lose money for each $100 of sales.  There could still be other challenges, however.

Increasing Prices

One challenge is figuring out how much to raise prices.  First, let’s assume that lumber doubled, so Abner reacted by doubling his prices.  If Abner still sold the same number of jobs, his profits likely will more than double, since his sales price doubled, and his lumber doubled, but his other costs did not double.  Depending on the market, doubling prices when one cost doubles might price yourself out of the market.

Imagine Abner realized that his market would not allow him to double his prices, so he only increased his sales price by the same amount that this lumber increased.  Abner might find that he is less profitable.  One reason is if Abner gives discounts off the total sales price to some customers.  For example, if Abner gives a 2% discount for timely payment, and if he increases his sales price, then 2% of the new sales price is more dollars and cents than 2% of the old sales price.  What if Abner gives discounts to certain other businesses that are even more than 2%?  Those discounts could be even more dollars and cents after Abner increased his prices.  Also, even if Abner were able to maintain the same profit in dollars after increasing prices only enough to offset the increase in lumber, his net profit percentage would decrease, because as a percentage his profits would be lower.  It would be the same profits (numerator), but a higher sales number (denominator).

Increasing Inventory

Another way the cost catapult could hurt Abner’s business is by increasing inventory costs.  Assume that Abner has X quantity of inventory in stock.  Now, assume that the cost of that inventory doubles.  If Abner counts the quantity of inventory, it is the same as it always was.  The money that Abner has tied up in inventory, however, may have doubled along with the cost.  Abner therefore needs more capital to simply sustain his normal inventory.

When inventory costs catapult, a business owner may find himself in the strange position of making higher profits but having less cash.  How is this possible?  If the business owner increases prices enough, there might be more profits.  The profits might need to go to fund the higher cost of inventory.

Increasing Lead Times

Abner may need more capital to sustain his inventory with normal lead times if costs rise. It is even possible that Abner might increase his inventory quantity if he is having trouble getting product in time.  Increasing the quantity of inventory that has already increased in price can be quite capital intensive.  Abner may want to consider these capital needs when he considers how much to charge his customers.  He might also want to consider negotiating with vendors for payment terms, and he might consider talking with his banker.

Gravity

Catapulting a stone causes danger on the way up.  Gravity also poses a risk as the stone hurls earthwards.  What would happen to Abner’s company if suddenly the cost of his inventory fell drastically, after he stocked up on inventory at a high price?  Would the market force him to sell some of the inventory at a loss?  Abner may want to ask himself if he has enough financial margin to sustain the business if his costs of materials drop significantly, potentially forcing him to cut his prices.

Pay Attention

If a real catapult suddenly showed up at work and started flinging stones, it would get the attention of the business.  Action might be taken to mitigate the risk.

Fortunately, real catapults don’t normally show up at jobsites.  However, catapulting prices have affected the economic landscape recently.  Are you paying attention to your costs and your prices?  Are they healthy?

Proverbs 27:23 Be thou diligent to know the state of thy flocks, and look well to thy herds.

This article is general in nature, and it does not contain legal advice.  Contact your advisors to discuss your specific situation.

Preface: Millions and millions of people don’t pay an income tax, because they don’t earn enough to pay on one, but you pay a land tax whether it ever did or ever will earn you a penny. You should pay on things that you buy outside of bare necessities. I think this sales tax is the best tax we have had in years. –Will Rogers

Navigating the Labyrinth of Sales Tax Compliance

Credit: Matthew P. Glick

So, you’re a small business owner, or you’re thinking of becoming one in the near future. You’ve taken the plunge, and you’re starting to see the return on your investment. But now, you just started researching sales tax (Or just started reading this article), and all of the sudden, your head is spinning a million details, and you’re just trying to figure out where you’re supposed to start. Sales tax is intimidating, and it can be difficult to know where to start. First of all, there are fifty states in the US (not to mention five additional territories), each with the power to levy a tax on the sale of items in that state/territory. Compounding the issue, is that each county and city can also impose an additional tax on sales that happen within the county/city. In all, that brings the total number of sales tax jurisdictions in the US to well over 10,000. To further complicate matters, each jurisdiction can have its own rules on what is considered taxable, and can also set its own tax rate. Is your head spinning yet?

While sales tax compliance is a very tedious process, I hope this article will help you understand where your business stands in this area, and give you a good starting point to do some additional research. If in doubt, you will want to pull in the advice of a qualified CPA or tax attorney to help you through the process.

Some of you may be thinking “Yeah, that’s a lot of stuff to keep track of if you’re managing a large enterprise like Walmart, but how does this apply to me?” Excellent question, the reasoning is simple: I don’t have a presence in any of these other jurisdictions, so why do I need to worry about their laws?

This reasoning was true once upon a time, until 2018, when the United States Supreme Court ruled in South Dakota v. Wayfair, Inc. that a physical presence was not necessary in a state to give that state the power to tax sales into that state. This overturned the decision also made by the Supreme Court in Quill Corp. v. North Dakota, which ruled that a physical presence was necessary in order for the state to levy a tax on the sale.

So what happened that caused the Supreme Court to overturn its prior decision? The most obvious factor is changes due to technological advances. To put this in perspective, the Quill decision was based on the presence of floppy discs being shipped into the state.

The Supreme Court ruled that a shipment of floppy discs did not constitute a physical presence in the state. Since then, with the advent of the internet, ecommerce is a booming industry, and thanks to solutions such as Shopify and Americommerce, it is now available to small and large businesses alike. Previously, states had to levy a tax on the use (Use tax) of items within their state to recoup lost sales tax dollars due to online sales, which would be the buyer’s responsibility to pay to the state, rather than the seller’s. As buyer’s compliance with use tax reporting is astronomically low, South Dakota sought to pass a law that would overturn the physical presence rule for collecting sales tax, and did so successfully.

So, we just established that if you are a small business, and your sell items or services out of state, you may need to comply with over 10,000 individual laws. Now what? The answer will vary depending on the way your business is structured, and how you market your products or services. The first thing to consider is the volume of out-of-state sales that you deal with. If your gross receipts for sales within a certain state are under $100,000 and less than 100 transactions, chances are low that additional research is required.

Keep in mind that each state measures sales differently. Some use gross receipts, others use net sales; some measure it over the calendar year, and others measure it on a continuous basis over the past twelve months, but a quick look at gross receipts should be good indicator if more research is required.

Then of course you need to research the products and services you offer, and find out if those items or services are taxable. Again, each jurisdiction has different rules regarding what is taxable. As a general rule of thumb, tangible personal property is taxed, and necessary items such as food and medication are exempt.

Again be sure to verify, as each state has different nuances to their exemptions, but this rule of thumb can help you understand what to expect. Services are much more tricky, as some states tend to tax services, while others do not.

The good news is that most online ecommerce platforms are equipped to handle these challenges by integrating with services that will automate sales tax compliance for a fee. These services may calculate sales tax, and allow you to file it on your own, or may even file the appropriate returns for you, depending on the level of service you subscribe to. Searching “Sales tax compliance software” into a search engine should help you locate a provider.

If you only offer your products from a brick-and-mortar location, and only do local deliveries if any, your job is even easier. Simply research to verify your state’s sales tax rate, and confirm to make sure your county and city don’t also levy a sales tax. You can take advantage of this free tool by Avalara to look up sales tax rates by typing in the address.

If this seems like a lot, it’s because it is. The good news is that there is software out there to help you stay compliant, and these solutions tend to scale with your company, making the investment palatable even in the beginning stages of your company. While it’s not a perfect solution, it is better than no solution, and noncompliance can be costly, as back taxes, along with penalties and interest can stack up quickly.

Our team at Sauder & Stoltzfus is willing to help. Get in touch with us to see how we may be able to assist you in becoming or staying compliant with sales tax regulations.

Preface: We will ensure that associates continue to possess unsurpassed product knowledge and maintain their dedication to customer service and respect for their colleagues and for the communities in which they work and live. — Arthur Blank

Home Depot: Two Good Guys Success

“Bernie Marcus and Arthur Blank dreamed up The Home Depot from a coffee shop in Los Angeles in 1978. Avid DIYers, they envisioned a superstore that would offer a huge variety of merchandise at great prices and with a highly-trained staff. Employees would not only be able to sell, but they would also be able to walk customers at every skill level through most any home repair or improvement.

With help from investment banker Ken Langone and merchandising guru Pat Farrah, Marcus and Blank opened the first two Home Depot stores in Atlanta the following year. The 60,000-square-foot warehouses dwarfed the competition with more items than any other hardware store. But the heart of Home Depot was the expertly trained floor associates who could teach customers how to handle a power tool, change a fill valve or lay tile. It wasn’t enough to sell or even tell — associates also had to be able to show. Soon, The Home Depot began offering DIY clinics, customer workshops and one-on-one sessions with customers.

Marcus and Blank implemented a customer “bill of rights,” which stated that customers should always expect the best assortment, quantity and price, as well as the help of a trained sales associate, when they visit a Home Depot store. These commitments were an extension of the company’s “whatever it takes” philosophy.” [i]

Bernie Marcus was the son of a poor Russian Orthodox Jewish immigrants. With ambitions to be a psychiatrist during his high school years, but unable to afford college or medical school, he faced his career realities and obtained a job in discount retail. His map to the entrepreneurial launch point began at United Shirt Shops eventually leading him to Two Guys discount Store in New Jersey. With a sharp-eye towards making the journey count, he was soon in charge of more than $1.0B in business at Two Guys. That position gave him the visibility for an opportunity to obtain an executive position with Handy Dan Home Improvements Centers where he was chairman and CEO.

Arthur Blank was raised in Queens New York. He learned the accounting trade and obtained a job at Arthur Young & Company following his formal education. Blank then joined his family’s pharmaceutical business that was purchased by Daylin Corporation. Daylin was an investor in Handy Dan Home Improvements Centers.

Bernie offered Arthur a job at Handy Dan and the two enterprising future business partners soon became best friends. Soon the Daylin Corporation CEO set the two free to pursue their dreams from that coffee shop conversation in 1978, by firing them both. As Bernie and Arthur made their way out the door, the CEO Mr. Langone told them to “open up that store you talked about!”

They initially considered such names as MB Warehouse and Bad Bernie’s Buildall, and then an investor suggested the name Home Depot.  Working business connections with Ken Langone a New York investment banker who organized the initial group of investors, and merchandising consultant Farrah helped that coffee shop dream to bud into a very successful enterprise.

When they opened the first store, Home Depot had so few customers that if Bernie or Arthur saw someone leaving their store empty-handed, they took it personally. The legacy of Home Depot is build on the tenet that they are in the training business, and that they are the college for learning flooring installation, kitchen and bath remodeling, millwork and even computerized registers.

Bernie and Arthur summarize the impressive ascension from humble beginnings to entrepreneurial  success as learning how important the folks are with whom they surrounded themselves, and that is their secret — they surrounded themselves with people at the Depot who were better, smarter, and more talented than they were, and invited them along on the Home Depot train.

[i] https://corporate.homedepot.com/about/history

Preface: Taxes are not good things, but if you want services, somebody’s got to pay them so they’re a necessary evil. –Michael Bloomberg.

Historical Individual Income Tax Trends

Credit: Benuel B. Glick, EA

Overview

It has been said that death and taxes are two unavoidable facts of life. While it may not be quite that simple, there may be some truth to it. And, as the humorist Will Rogers said a century ago, “The difference between death and taxes is death doesn’t get worse every time Congress meets.” In fact, death is a much-anticipated liberation for the follower of Jesus.

In this article, we’ll briefly explore the history of America’s individual federal income tax rates. We will not look at all the shades or governmental motives for taxation. Nor will we get into excise, tariff, sales and use, corporate, investment, real estate, payroll, social security, estate and inheritance, gift, capital gains, tangible personal property, or state and local taxes. “Taxes” and “tax rates” will be referring to “individual income taxes” and “individual income tax rates” respectively.

Trying to cover all the nuances of calculating the tax rates would quickly turn this article into a book, and the graph shown above only highlights overall trends since 1913. It does not reflect exemptions, phase-outs, credits, blended rates, etc. However, excluding many additional factors, it does reflect the highest and lowest marginal individual tax brackets for given time periods.

Background

With some exceptions, the American government collected the majority of its revenues from duties, tariffs and excise taxes prior to 1913. In 1913 the 16^th Amendment to the U.S. Constitution was ratified by the states – albeit with much resistance – and a new era of taxation was born. In strong opposition of the 16^th amendment, speaker of the Virginia House of Delegates Richard E. Byrd warned: “A hand from Washington will be stretched out and placed upon every man’s business; the eye of the Federal inspector will be in every man’s counting house.…” Sound prophetically accurate?

Included in the 16^th Amendment is the following: “The Congress shall have the power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.” In short, the United States Congress was finally allowed to directly assess income taxes on individuals without permission from the states, or anyone else for that matter. It’s not difficult to guess what Congress did next.

Modest Beginnings

Initially, the tax rates appeared modest enough with taxable income under $20,000 taxed at 1%, and the highest bracket of over $500,000 taxed at 7%. That didn’t last long. In October of 1917, shortly after declaring war on Germany (WWI), Congress passed the War Revenue Act which drastically increased the tax rates. In 1918 the top bracket for income over $1M was taxed at a whopping 77%! As the saying goes, strike while the iron is hot.

The 1920’s are often referred to as the ‘roaring 20s’. World War 1 ended in 1918, and Congress nimbly lowered the top tax rates in subsequent years. The 1920’s saw a significant top rate reduction; however, it was accompanied by much lower thresholds. By 1925 the top rate was at 25%, but that included all taxable income over $100,000.

New Era of Taxation

Black Tuesday crashed onto the financial stage on October 29, 1929, and decades of high taxation followed suit. By 1940, the top tax rate was at 81.1% on income over $5M. Not satisfied with the current state of affairs, president Roosevelt actually pushed for a top tax rate of 100% and is quoted as saying to Congress in April 1942, “…I therefore believe that in time of this grave national danger, when all excess income should go to win the war, no American citizen ought to have a net income, after he has paid his taxes, of more than $25,000 a year.” In addition to his New Deal, he was calling for more funds to alleviate the WWII financial burdens. You might say he reached 94% of his goal by 1944 when tax rates had reached 94% on taxable income over $200,000!

Taxes remained high During the rest of the ‘40s and all through the ‘50s with a marginal top rate of 91% on income over $400,000 from 1954 through 1963. It’s important to maintain perspective though, an estimated fewer than 10,000 households would have reached the top bracket in 1950 per a Wall Street Journal article.

In 1964, president Lyndon B. Johnson signed the largest pre-Reagan-era tax cuts into law. A top marginal rate of 77% on income over $400,000 might sound ridiculous to the current generation, but it was a welcome relief for wealthy earners in 1964. The top rate dropped to 70% in 1965, accompanied by a threshold drop from $400,000 to $200,000. The top marginal rates bounced around within the 70-77% range during the remainder of the ‘60s and for all of the ‘70s, and were generally triggered by the top tier income over $200,000.

Modern Era of Taxation

When America’s 40^th president, Ronald Reagan, was inaugurated on January 20, 1981, the economic climate was ripe for a legislative revolution of sorts. During Reagan’s tenure in office – from 1981 to 1989 – he incrementally slashed the top marginal tax rate for individuals from 70% down to 28%. It is important to note that this top rate of 28% was triggered by taxable income of approximately $30,000.

In 1993, newly elected president Bill Clinton proposed an ambitious budget to cut the national deficit in half by 1997, and signed the Omnibus Budget Reconciliation Act into law. Among many other things, this bill increased the top marginal rate to 39.6%, accompanied by a $250,000 threshold.

From 1991 through 2018 we see a consistent top rate in the 35 – 40 percent range. The top marginal rate remained at 35% with a threshold of $311,950 from 2003 to 2012. In 2013 it increased to 39.6% accompanied with a $450,000 threshold. In 2018 the top marginal rate decreased to 37% with a $600,000 threshold.

In this article we glimpsed into the historical tax trends for American individuals over a 105 year span. I’ll refrain from making a prediction for the next 105, but I am reminded of a wise saying from millennia ago: “The thing that hath been, it is that which shall be; and that which is done is that which shall be done: and there is no new thing under the sun” (Ecclesiastes 1:9 KJV).

 

Preface: In the long run we shall have to pay our debts at a time that may be very inconvenient for our survival. — Norbert W.

Business and Nonbusiness Bad Debts

It is virtually inevitable that at one time or another some taxpayers will incur financial investment losses either in business or personal lives. One frequently occurring type of loss is a bad debt. Whether made in the course of business, or to a friend or relative, sometimes a loan simply cannot be repaid despite the best intentions of the debtor, and if there is little or no prospect that repayment can be made in the future.  In those cases, a “bad debt” may exist for tax purposes. The issue then becomes whether you can salvage some tax benefit from not being repaid.  Although this subject is fraught with complexities, we have outlined the basic tax principles below so you may consider your options.

The first step is ascertaining that a real debt exists. There must be a valid and legally enforceable obligation to pay you a fixed or “determinable” sum of money. Loans between family members, or other related parties such as corporations and their shareholders, are particularly scrutinized to make sure that they are really debts rather than disguised gifts, dividends, or contributions to the corporation’s capital. Therefore, if you are contemplating a loan to a related party, you must ensure that you treat the transaction as a true loan by taking the steps that an arm’s-length lender would take, such as putting it in writing and charging a reasonable rate of interest.

Secondly, it then must be determined if, and when, the debt has become totally or partially worthless. If so, that is a bad debt. One problem, however, is that the IRS often requires taxpayers to play a guessing game. A taxpayer might claim a bad debt loss when nonpayment is only probable, rather than a virtual certainty, and then the IRS may disallow the loss as premature because there is some possibility of repayment in a later year. On the other hand, if the taxpayer waits until repayment is clearly hopeless, the IRS may maintain that the debt was really worthless in a prior tax year and determine that the loss should have been taken then. Because of potential statute of limitations problems, we generally recommend that the loss be claimed in the earliest possible year that it can reasonably be argued to be worthless. There are a number of facts which might indicate worthlessness, including the debtor’s bankruptcy, but no one of them is decisive; it is the totality of circumstances that is determinative.

Once you have established that a bad debt exists, you must also determine whether that debt had a business or nonbusiness nature. The specific tax deduction to which you may be entitled often hinges upon this characterization. As you might expect, a business bad debt must be created or acquired, or become worthless, in the course of your trade or business. If you conduct a business in the form of a corporation, generally any debt held by the corporation is a business debt. Any debt not falling into the business category is a nonbusiness debt. A nonbusiness debt must be completely worthless before a loss can be taken, whereas a loss on a business bad debt can be taken when partial worthlessness can be established. Furthermore, nonbusiness bad debts are subject to the limitations on capital losses. Business bad debts, on the other hand, are deductible as ordinary losses in full against your other income.

As we said above, this is a complex topic and the preceding discussion can give only a rudimentary overview of all of the tax rules involved. If you are, or may be in a situation where these rules could affect you, please do not hesitate to contact us.