Double Taxation: A Take On All Things Taxes

As the week comes to a close, Senate Democrats scramble to finalize legislation pushed for by President Obama earlier this month, most notably the extension of the soon-to-expire Bush tax cuts for all taxpayers earning less than $250,000 ($200,000 for single.)  The bill is still being tweaked, but it appears that not all the President’s proposals are being incorporated, with the most notable deviation the capping of the tax rate on dividends at 23.8%. 

Proposed Legislation Mirroring Previous Obama Proposals:

•  Top ordinary rates from those earning in excess of $250,000 would increase from 33 and 35% to 36 and 39.6%.
• For those earning less than these thresholds, the top rate would remain 31%.
• The top long-term capital gains rate would rise from 15% to 23.8%.

 Proposed Legislation Differing from Obama Proposals:

•  The President had proposed returning the estate tax to its 2009 parameters: a 45% rate and $3,500,000 exemption. The Senate bill is expected to drop that change, allowing the fate of the estate tax to be handled in future legislation. Should nothing happen between now and year-end, however, the estate tax is set to sunset to a 55% rate and a paltry $1,000,000 exemption.
• President Obama has pushed for dividends to once again be taxed as ordinary income, meaning for those earning in excess of $250,000, dividend rates would climb from 15% to 43.4%, after factoring in the additional 3.8% tax on investment income. The bill, however, splits from that proposal, calling for a top rate on dividends of 23.8%.
• The AMT would continue in 2012 with a one-year exemption patch. The President has long pushed to replace the AMT with a “Buffett Rule” that would impose a minimum effective tax rate of 30% on those earning in excess of $1,000,000.

The Democratic-controlled Senate needs 60 votes to move the bill along, which is precisely why the estate tax language was recently removed. There has been dissent among Democrats as to the right parameters for a future estate tax regime — with some supporting Obama’s decision to raise the rate to 45% and lower the exemption to $3.5 million, while others prefer to keep the current standards of a 35% rate and $5.2 million exemption —  raising concern that the inclusion of any estate tax language would prevent the legislation from receiving the required support.

The hope is that the bill will be ready for vote next week. From a posturing perspective, Democrats are obviously extremely hopeful the legislation will pass the Senate, so that if the bill hits a roadblock in the Republican-led House, the finger can be squarely pointed at the Republican party for failing to embrace “middle class tax relief.”

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Rosa Ditaranto filed her 2008 tax return in May, 2011. Generally speaking, that’s a problem. Ditaranto owed a significant liability with the return, on to which the IRS graciously tacked the following penalties:

“Failure to file” penalty pursuant to I.R.C. § 6651(a)(1): $24,820

“Failure to pay” penalty pursuant to I.R.C. § 6651(a)(2): $8,825

As a reminder, I.R.C. § 6651(a)(1) imposes the “failure to file” penalty when a taxpayer does not file their return by its properly extended due date. The amount of the penalty equals 5% of the tax required to be shown on the return for each complete or partial month the return is late, not to exceed 25% in the aggregate.

Section 6651(a)(2) imposes a corresponding “failure to pay” penalty for failing to pay timely the tax due on a Federal income tax return. The amount of the penalty equals 0.5% for each complete or partial month a taxpayer fails to pay the tax, not to exceed 25% in the aggregate.

The additions to tax under Sections 6651(a)(1) and (2) are imposed on the net amount due, meaning that the amount of tax due on the return is reduced by the amount of tax paid on or before its due date and allowed as a credit on the return.

Importantly, there is an exception to these penalties when a taxpayer can prove that the failures to pay and file were due to reasonable cause, and not willful neglect. Whether “reasonable cause” exists generally requires a facts and circumstances approach. 

Ditaranto argued that her failures to file timely and to pay timely were due to a confluence of personal, professional, and financial difficulties that she faced between late 2000 and late 2011. Among the circumstances she cited on brief were:

2001: Her checkbook was stolen.

2001-2004: Her former business partner denied her access to records during a protracted lawsuit.

2004: Flood.

2010: Mother’s illness.

2011: Mother’s death.

2011-2012: Financial difficulties.

The Tax Court, while not unsympathetic to Ditaranto’s plight, concluded that none of these difficulties constituted “reasonable cause” for failing to handle her tax obligations. In reaching its decision, the court relied on the “life’s a bitch” judicial doctrine, maintaining that if  you were to look at a 10-year span of anyone’s life, you’re bound to find the same smattering of nagging inconveniences and legitimate problems that plagued Ditaranto. 

To test the court’s theory, I put together a brief chronology of my own worst moments from the past decade:

2002: Girlfriend leaves me for much shorter man.   

2005: Wonka inexplicably discontinues delicious Laffy Taffy “Flavor Flippers” candy treat.

2006: Relentlessly bullied by Cobra Kai.

2007: Kim Kardashian discovered.

2008: Brain aneurysm.

2010: Kid learns to walk.

2011: Phillies lose NLDS Game 5 to Cardinals 1-0.

I must say, that was almost therapeutic. But while this list may paint a sadder picture than I anticipated, it does nothing to relieve me of my tax obligations. So if you intend to argue “reasonable cause,” be prepared to establish that there was at least one of the following:

• unavoidable postal delays;
• the death or serious illness of a member of the family;
• destruction of your records or place of business,
• the reliance on erroneous information given by an IRS employee, or
• the reliance on bad advice given by a tax professional.

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