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Cash for Clunkers: If your car is worth less than $4,500 and gets under 18 MPG, read on. If you just want to read about another ineffective government program, read on.

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As you may have heard, Congress recently passed the “cash for clunkers” program. The program covers new vehicle purchases between July 1, 2009 and November 1, 2009. The basic idea is: you trade in your old, gas-guzzling car for a more fuel efficient car and get an allowance of $3,500 or $4,500 depending on how much more fuel efficient the new car is.

How does it work, you ask. Well…

The government issues electronic vouchers to auto dealers that sign up for the program. Dealers can use these vouchers to reduce the purchase price of a new vehicle by $3,500 or $4,500 for customers who trade in an old, gas-guzzler. When customers buy cars, the dealers will submit these vouchers to the Feds and receive payment within 10 days.

Rules for New Passenger Autos

A new passenger auto must have an MSRP of no more than $45,000 and have a Combined Fuel Economy (CFE) rating of at least 22 mpg. The old clunker must have a CFE of 18 MPG or lower. Leased cars can qualify, but the lease has to be for at least 5 years…good luck finding a 5 year lease.

The dealer gets the $3,500 allowance if the new auto’s CFE is at least 4 MPG higher than the trade-in’s CFE. If the new auto’s CFE is at least 10 MPG higher, the dealer gets the $4,500 allowance.

Rules for New Trucks and Vans

There are three sets of rules for various size trucks and vans.

 

Category 1
SUVs and Small to Medium Sized Pickups and Vans

Category 2
Larger Pickups and Vans

Category 3
Trucks between 8,500 and 10,000 pounds

New Vehicle CFE Requirement

At least 18 MPG

At least 15 MPG

NONE

$3,500 Allowance

At least 2 MPG increase over old vehicle

At least 1 MPG increase over old vehicle

Allowed for model year 2001 or earlier trucks traded in for a Category 2 or 3 truck

$4,500
Allowance

At least 5 MPG increase over old vehicle

At least 2 MPG increase over old vehicle

NOT AVAILABLE FOR WORK TRUCKS

The trade-in vehicle:

  • must be in drivable condition
  • must have been insured and registered to the same owner for at least one year prior to the trade-in
    • this prevents people from buying clunkers at junk yards and immediately trading them in for the allowance.
  • must have been manufactured less than 25 years before the trade-in date
It is pointless to trade in a car whose value is higher than the cash-for-clunker’s allowance amount because the dealer has to destroy the car and won’t offer any trade in allowance over the cash-for-clunkers voucher.

This posting contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

High Taxes are No Laffer-ing Matter (Time for a Rant)

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The above graph is the Laffer Curve, named after economist Arthur Laffer. This graph demonstrates that when tax rates are increased past a certain rate, tax revenues will actually decline.  This is because as tax rates increase, people become more and more upset with more and more of their income being taken by government and spent inefficiently.  As they become more and more upset, they take more and more action to decrease their tax liabilities.  The important aspects of the Laffer Curve are:

  • At the 0% tax rate extreme, tax revenues are obviously $0
  • At the 100% tax rate extreme, tax revenues are also $0
    • Why bother working when the government takes 100% of your income?
    • Businesses close operations and move offshore to lower taxing countries (Ireland, Hong Kong, etc.)
      • "Taxes don’t redistribute income, they redistribute people"–George Gilder
    • People may work enough for basic sustenance, but they will likely report no income to the IRS
  • The revenue maximizing rate is represented by the green dot at the peak of the curve
    • The exact revenue maximizing rate is subject to strong debate
  • When the tax rate increases above the maximum point, tax revenues will actually start to decrease
    • By having more and more of their money taken away from them, people will take action:  They will
      • become much more aggressive in their legitimate tax planning
      • become involved in tax evasion (getting paid under the table)
      • cut back on work (why bother working when most of your income is taken by the government)
      • start asking, “Who is John Galt?”
  • The horizontal line running through the two blue dots shows that an equal amount of revenue can be raised at two different tax rates–a low rate and a high rate
  • Between the high rate and the low rate, Congress should set taxes at the low rate because the higher rate will constrain economic growth

People who favor tax increases (interesting how it’s always tax increases on OTHER people) somehow believe that an X% increase in tax rates will lead to an X% increase in tax revenues.  This is economically similar to a business raising its prices 10% and expecting revenues to also increase 10%.  By increasing its prices, the business is lowering demand for its product, and people buy less (either forgoing the product all together or buying from a competitor). 

People have choices in life—they can work or they can enjoy leisure time.  It requires a certain wage for people to forgo leisure time and work.  So, let’s say that you’ve worked 40 hours this week.  To entice you to work an extra hour, your boss offers you $20.  You say “no way, I’ve worked enough this week”.  You turn down working the extra hour because your leisure time is worth more than $20.  Your boss then offers you $30.  You agree because the $30 wage is worth more than an hour of your leisure time.  Now let’s say the government imposes a 35% income tax.  The $30 wage that enticed you to work that extra hour is now worth only $19.50 ($30 wage less tax of 35%).  Since this after-tax wage is worth less than an hour of your leisure time, you choose leisure over work.  Just a quick example of how a high tax on income can shift productive activity to leisure.  By the way, this harms economic growth :( 

Let’s take a look at CURRENT business and personal tax rates:

Top federal tax rate:                    35%

Michigan personal tax rate:       4.35%

Michigan Business Tax Rates:

    Business Income Tax:            4.95%

    Gross Receipts Portion*:           0.8%

Total Tax Rate                         45.10%

These figures don’t include self-employment taxes of 12.4% on the first $106,800 of self employment income plus 2.9% of all self-employment income. 

* The gross receipts portion is based on gross receipts, not profit.  As a percent of net income, it is greater than 0.8%.

Renters Can Claim the Michigan Homestead Property Tax Credit, Too.

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The State of Michigan offers a refundable Homestead Property Tax Credit of up to $1,200 per year for property taxes you pay on your homestead (principal residence). 

Many people who rent their homes or apartments often do not claim the credit since they are paying rent, and not property taxes.  However, a portion of the rent paid actually is used to pay property taxes on the home. 

The State of Michigan assumes that 20% of rent paid is for property taxes.  Therefore, if you pay $900 rent per month ($10,800 per year), 20% of the rent paid is considered payment of property taxes eligible for the property tax credit.  In this example, the 20% of rent that is deemed payment of property taxes amounts to $2,160.

Two more complexities:

  1. you have to reduce the property taxes you paid by 3.5% of your household income.  So, let’s say you make $40,000 per year.  The $2,160 property taxes you paid is reduced by $1,400 ($40,000 * 3.5%) and this leaves $760 of property taxes eligible for the credit. 
  2. to compute the credit,  you multiply the $760 by 60% and the amount of your refundable credit is $456.

To recap:

  1. Compute your deemed property taxes by multiplying your rent by 20%
  2. Reduce your property taxes paid by 3.5% of your household income
  3. Reduce the product computed in Step 2 by 60%
  4. Deposit your refund check

This posting contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

MBT Tax Savings for Service Businesses with Out of State Clients

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Hey, are you excited about the new Michigan Business Tax?

Neither am I.

But there is a bit of good news for services businesses with out-of-state clients.

Service businesses can reduce their MBT tax by “sourcing” their revenues out of state if the benefit of their service is received outside of Michigan. Under the old SBT, service revenues were generally sourced to the state where the services were performed.

Example: A management consultant in Michigan with $700,000 in revenues has a client in Ohio. The Ohio client provides $400,000 of the management consultant’s revenues. Normally, the management consultant would be subject to MBT because her revenues exceed the filing threshold of $350,000.

However, since the benefit of the consultant’s services are enjoyed in Ohio, the revenues can be sourced outside of Michigan. The consultant’s Michigan revenues are now $300,000 and the consultant is now under the MBT filing threshold and will have no MBT tax liability.

Under the SBT, the revenues would be sourced to Michigan, since this is where the services were performed.

While this strategy may not get you under the filing threshold, it may qualify you for more tax credits and lower your overall tax.

Taxpayers must have “nexus” with the outside state(s) to source revenues outside of Michigan. Nexus exists where:
1) the taxpayer has physical presence in the outside state for more than one day

OR

2) the taxpayer actively solicits in the outside state and has more than $350,000 in revenues sourced to that outside state

The MBT statute defines “state” to include foreign countries. So if you perform services for a Canadian client (or a client in any other country), these revenues can be sourced to an outside “state.”

This posting contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

2009 Mileage Rates

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The mileage rates for 2009 for calculating your mileage deductions are as follows:

Business use of your car: 55 cents per mile
Use of your car for medical care or as part of a deductible move: 24 cents per mile
Use of your car for charitable purposes: 14 cents per mile

Expecting Capital Losses? Use Them to Shelter Capital Gains.

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The rules on deducting capital losses are pretty strict. You can deduct capital losses against capital gains. Capital losses can also be deducted against $3,000 of your ordinary income per year. So if you have only ordinary income, no capital gains, and a $30,000 capital loss, it would take you 10 years to fully deduct the capital loss.

If you have such large capital losses, you should review your stocks to see if any have appreciated in value. You can then sell the appreciated stock and generate capital gains. These capital gains will be sheltered by the capital losses. You can then repurchase the stock and obtain a a higher tax basis that reflects its current price.

Our Friend, the Laffer Curve

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The above graph is the Laffer Curve, named after economist Arthur Laffer. This graph demonstrates that when tax rates are increased past a certain rate, tax revenues will decline.

The important aspects of the Laffer Curve are:

  • At a 0% tax rate, tax revenues are $0
  • At a 100% tax rate, tax revenues are also $0
    • No one works when the government takes 100% of his/her earnings
    • Businesses will close operations and move offshore
      • “Taxes don’t redistribute income, they redistribute people”–George Gilder
    • People may work enough for basic sustenance, but they will likely report no income to the IRS
  • The revenue maximizing rate is represented by the green dot at the peak of the curve
    • The exact revenue maximizing rate is subject to strong debate
  • When the tax rate rises above the maximum point, tax revenues will decrease
    • By having more and more of their money taken away from them, people will become discouraged and will not work as long or as productively
  • The horizontal line running through the two blue dots shows that an equal amount of revenue can be raised at two different tax rates–a low rate and a high rate
    • Between the high rate and the low rate, Congress should set taxes at the low rate because the higher rate will constrain economic growth

Arthur Laffer and Stephen Moore (from the Wall Street Journal) have a new book called “The End of Prosperity–How Higher Taxes Will Doom the Economy, If We Let it Happen.” It is an excellent read and explains how lower taxes and other supply side principles fuel economic growth. It is available through the Recommended Books link above.

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What is Tax Fairness?

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Tax reform is almost always a topic during presidential elections. This post will discuss some concepts and ideals of tax fairness. The following principles are usually debated in discussing fair tax policy:

  • Simplicity
    • the tax rules should be simple
  • Transparency
    • the amount of tax paid should be visible to taxpayers
    • for example, when you buy a $20,000 car, the $1,200 of sales tax is visible to the buyer on the car invoice
  • Stability
    • the tax laws shouldn’t constantly change
    • constantly changing tax laws increase complexity and reduce predictability
  • Growth Promotion
    • taxes should raise revenue for necessary government expenses and should consume as small a portion as possible of national income (GDP)
  • Neutrality
    • taxpayers with equal amounts of income should pay equal amounts of tax–tax policy should not subsidize/penalize different types of income and deductions

The Candidates’ Tax Proposals

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For those who are interested in learning more about Senators Obama’s and McCain’s tax proposals, there are a couple of tax think tanks that have published studies of the impacts of both plans. The Tax Policy Center (which is slightly left leaning), is a joint venture of the Urban Institute and Brookings Institution released an updated study on September 12 on the tax plans. The Tax Foundation, which is a slightly right-leaning think tank, also released a study on September 19. The Tax Foundation also explains how both candidates misstated tax facts during the first two debates.

Recordkeeping Requirements

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The IRS usually has 3 years to audit a tax return. However, if there is a 25% or greater understatement of income, the IRS has up to 6 years to audit. If the taxpayer has committed fraud, the IRS can go as far back as it wants. The IRS has a policy of NOT going back more than 6 years, but this is just policy–it can be changed at any time.

To ensure that you have support for your income and deductions, you should generally keep records for 7 years (the maximum six years the IRS can go back, plus 1 year for good measure).

If you don’t keep adequate records, the IRS can reconstruct your income using various methods including:

  1. The Net Worth Method: The IRS determines your net worth at the beginning of the tax year and at the end of the tax year. The difference is income. The IRS then adds nondeductible expenses, payments of federal income tax, and gifts paid to others. The IRS will then tax you on this sum.
  2. The Expenditures Method: The IRS looks at your expenses for the year and compares them to your income. If the expenses exceed income, the IRS assumes the excess is income and applies a tax.
  3. The Deposits Method: The IRS assumes that your bank deposits are income and applies a tax unless you can prove that the source of the deposits was tax-exempt.

So, what type of records should you keep and for how long?

These items should be kept for 7 years:

  • cancelled checks
  • credit card receipts
  • paid invoices
  • bank deposit slips
  • bank statements
  • tax returns (uncomplicated)
  • employment tax returns
  • expense records
  • inventory records

The following items should be kept for the life of the asset (or business) plus 7 years:

  • corporate minutes
  • depreciation schedules
  • real estate records
  • general ledgers
  • home purchase & improvement records
  • investment records

The following items should be kept permanently:

  • complicated tax returns
  • contracts
  • corporate stock records

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