Warning: Fiscal Cliff Ahead

Fiscal crisis looms for winner of the presidential election

Consumers, banks and businesses have been busy getting their balance sheets into better shape since the U.S. economic recovery began more than three years ago. Now, it’s the government’s turn.

 Whoever wins the presidency will contend with a budget on a trajectory dubbed unsustainable by Federal Reserve Chairman Ben S. Bernanke. Barack Obama or Mitt Romney will have to tame a deficit that has topped $1 trillion in each of the past three years, Bloomberg Markets magazine reports in its November issue. How the new president goes about it will influence the direction of financial markets and define the economy and society for his four-year term and beyond.

 “We’ve made a lot of progress getting the private-sector balance sheet in order,” says Mark Zandi, chief economist at Moody’s Analytics in West Chester, Pennsylvania. “Where we’ve got a lot of work to do is on the public side.” Research from Harvard University economists Carmen Reinhart and Kenneth Rogoff shows why it’s necessary to do that work. Their data on sovereign indebtedness, which go back more than two centuries, demonstrate that growth has been hobbled when central government debt is more than 90 percent of annual gross domestic product five years in a row. The U.S. is now at the Reinhart-Rogoff debt threshold.

Gross federal debt has exceeded 90 percent of GDP for the past two years and is projected to remain above that level through 2017 at least, according to the White House’s Office of Management and Budget. Even publicly held debt, which excludes the special-issue securities held by the Social Security trust fund and other government agencies, reached 68 percent of GDP in 2011.

 ‘Subpar Economy’

 “It’s not about we’re going to have a financial crisis tomorrow,” Reinhart says. “We’re just going to have this subpar economy.”

 The sea of red ink is pushing business executives to get involved in the debt debate and should force political leaders to act, says David Cote, chief executive officer of Honeywell International Inc., who was a member of the debt reduction panel created by Obama and led by former Republican Senator Alan Simpson and former White House Chief of Staff Erskine Bowles, a Democrat. 

“We have more debt on a percent-of-GDP-basis today -- by a large amount -- than we did during the Reagan years, World War I, the Civil War, the Revolutionary War,” Cote said at the Bloomberg Markets 50 Most Influential Summit on Sept. 13. The only time the U.S. was deeper in debt was during World War II.“And then, we had a very good reason,” he said.

 Debt Clock 

Cote is on the steering committee of the Campaign to Fix the Debt, a group pushing for a comprehensive plan to get the federal budget on better footing.

Budget matters have permeated the presidential campaign. At their convention in Tampa, Florida, in August, Republicans displayed a running tally of the rising national debt -- 14 digits, about $16 trillion -- above the stage. A week later, at the Democratic convention in Charlotte, North Carolina, former President Bill Clinton reminisced about the budget surplus at the end of his second term in 2000.

 The costs of doing nothing are rising. Unless and until business leaders see that the gridlock in Washington can be broken, they’re going to be reluctant to make investments or hire more workers, according to Cote. The political inaction hurts growth. “What it causes you to do is sit there and say,’ I’m better off waiting right now. I shouldn’t spend my shareowners’ money until I have some sense of where things are going,’” he said.

Fiscal Cliff
Fear that politicians will be unable to reverse the long-term trend in the debt is compounded, in Cote’s view, by the possibility that they will fail to stop the huge tax increases and spending cuts scheduled to go into effect starting next year. Although leading the country off this so-called fiscal cliff would almost halve the budget deficit, economists say it’s exactly the wrong way to go about it if you want to limit harm to the economy. The abrupt austerity would likely strangle the fragile three-year-old recovery.

Maya MacGuineas, president of the Committee for a Responsible Federal Budget, based in Washington, says there’s growing support on Capitol Hill for tackling the debt in a constructive manner. She says she’s hopeful that a “grand bargain” to put the government’s finances on a sounder footing may be possible between a newly elected president and Congress, helped along by the need to deal with the fiscal cliff.

Grand Bargain

The term grand bargain is shorthand for a compromise that addresses the long-term trend of a budget that gets harder to balance as health-care costs rise and the population ages. The goal is to put a deal in place now that shows the government is committed to a plan to shrink the deficit -- without shocking the economy in the near term.

Alan Blinder, a former Fed vice chairman who’s now a professor at Princeton University, says his ideal policy would be $500 billion of stimulus up front coupled with $5 trillion in deficit cuts over the following 10 years. The former is unlikely, he says, with Republicans having made stimulus a dirty word in Washington. And the latter may not happen either, as long as interest rates stay low. Blinder says policy makers will likely tackle the debt piecemeal, with limited changes in the tax code and compromises on spending rather than an overarching agreement.

“There is more discussion about dealing with the deficit than I’ve heard in a long time,” says Howard Gleckman, resident fellow at the Urban Institute and editor of the TaxVox blog. Still, he says he remains skeptical that the talk will translate into action. Like Blinder, he says low interest rates allow policy makers to kick the can down the road.

Low Yields

Yields on Treasury securities are hovering near record lows as the U.S. benefits from its status as a safe haven for investors during a period of financial turmoil in Europe.

Politicians will be tempted to delay needed efforts to deal with the debt because borrowing costs are low, says Robert Litan, director of research for Bloomberg Government in Washington. “We have a lot more freedom to be irresponsible,” he says.

That’s a risky path, says MacGuineas, who has former politicians and policy officials from both the Republican and Democratic parties on her group’s board. “Playing chicken with the credit markets is a dangerous game,” she says.

A surge in borrowing costs is the likely scenario when debt gets out of hand. Rogoff, Reinhart and her husband, Vincent Reinhart, a former Fed official who’s now chief U.S. economist for Morgan Stanley, authored a paper earlier this year that examined 26 separate episodes in 22 countries in which central government obligations rose above the 90-percent-of-GDP mark.

Growth Hit

In the most common scenario, debt above that threshold led to higher interest rates that in turn created a drag on growth, the researchers found. In other instances, the economy slowed because of the need to raise taxes and cut spending, particularly on public investment. Either way, the hit to growth was inescapable.

“The long-term risks of high debt are real,” the economists wrote in their paper, published in April on the website of the National Bureau of Economic Research.

Advanced economies with debts above the 90 percent threshold grew on average 2.3 percent a year, compared with 3.5 percent growth in lower-debt periods, the research showed. The periods of elevated debt lasted an average of 23 years. In spite of the dangers, the economists said, they’re not advocating rapid reductions in government debt during times of extremely weak growth and high unemployment. 

Unemployment

Growth in the U.S. has indeed been subpar. Gross domestic product will expand 2.1 percent in 2013, not much different from the 2.2 percent growth expected for this year, according to the median forecast of economists surveyed by Bloomberg in September. Unemployment will stay high, averaging 7.9 percent for the year, economists predict. The jobless rate stood at 8.1 percent in August and had been above 8 percent for 43 straight months.

In the past, such a middling outlook would have had politicians talking about ways for the government to stimulate the economy. Not now. Instead, the focus is on how much -- and how quickly -- the government should scale back its support.

“It’s an odd situation,” says Dean Maki, chief U.S. economist at Barclays Plc in New York. “Usually, the choice is, do you do some stimulus and try to boost the economy? But now we’re talking about the extent of fiscal tightening.”

Romney’s Approach

Both President Obama and Republican nominee Romney promise deficit reduction -- although their approaches differ radically.

Romney, the former Massachusetts governor, pledges in his stump speeches and on his campaign website that he would balance the budget within a decade through deep reductions in government outlays, while devoting more resources to national defense. He wants to cut federal spending to 20 percent of GDP by 2016, from about 24 percent today. He also proposes to overhaul the tax code and federal health-care programs for the poor and elderly, while reducing income tax rates by 20 percent.

The broad outline of Romney’s plan implies a government with limited resources to maintain the social programs of the Great Society and the New Deal, although he hasn’t provided much detail on what spending he would cut and what tax deductions he would eliminate.

Obama’s Budget

Obama’s debt reduction goals are more modest. During the next 10 years, he would reduce, not eliminate, the deficit, according to the most recent White House budget proposal. He aims to stop the growth of the federal debt as a share of the economy while preserving the government’s role in aiding the needy.

The president proposes to reduce the budget gap through shallower spending cuts and higher taxes for top earners. He backs increased public investment as a way to promote economic growth.

After a decade, Romney’s proposals would be about $300 billion a year below Obama’s plan on revenue and as much as $1 trillion below it on spending.

“They do present a rather stark contrast, both in theory and in the numbers,” says Bob Bixby, executive director of the Concord Coalition, an Arlington, Virginia-based nonprofit group that advocates for deficit reduction.

Although fiscal responsibility is a perennial campaign promise, Alice Rivlin says there might be reasons to expect that debt reduction efforts will gain traction after the election on Nov. 6. Rivlin, the first director of the Congressional Budget Office back in 1975, points out that the president and the Republican speaker of the House, John Boehner, tried to negotiate a far-reaching budget pact last year as the confrontation over the debt limit roiled the capital.

‘Came Close’ 

“I believe that they came close,” Rivlin says. No one knows what will trigger action on the debt. “The last run-up to a very bitter campaign may not be the best moment to assess,” she says.“It may look better after the election.”

The crisis in the euro zone, where bond buyers have pushed up the borrowing costs for indebted countries such as Greece, Portugal and Italy, adds urgency to U.S. efforts to find a more sustainable budgetary path. 

Harvard’s Carmen Reinhart says instances of debt climbing above 90 percent of GDP in an advanced economy have been relatively rare since World War II. In the European examples, including Greece and Italy, the penalty for their fiscal irresponsibility can be seen in slower economic expansion over many years. “They’re not poster children for growth.”

‘Not Delusional’

For the U.S., Reinhart says, the debt reduction framework created by the Simpson-Bowles commission would be a good starting point for a political compromise. “It was bipartisan by people who were not delusional,” she says.

Rivlin, who was on the Simpson-Bowles commission, says the euro-area sovereign-debt crisis could be what forces action. If Europe falls apart completely, it would underscore the hazard of fiscal recklessness. If Europe begins to work through its problems, on the other hand, it would present investors with an alternative to safe-haven Treasury purchases -- and yields on U.S. government debt might start to rise. “Once Europe starts to get its act together, then we’ll be much more exposed.”

Rivlin and others point to the fiscal cliff as another possible trigger to get politicians moving -- or it could be an economic disaster. More than $600 billion of tax increases and spending cuts are slated to take effect in 2013 if Congress and the president can’t compromise and alter the statutes in place today. The tax cuts for income, dividends and capital gains enacted during George W. Bush’s tenure in the White House would expire. A payroll tax cut and extended unemployment benefits are also due to lapse. And some $65 billion in automatic cuts in government outlays -- half of them from defense -- would take effect as a result of last year’s deal to raise the debt limit.

Tax Increase

That would be deficit reduction on steroids, cutting the budget gap almost in half, to $641 billion. If lawmakers do nothing, 83 percent of all U.S. households would face tax increases, averaging $3,701, according to the Tax Policy Center, a nonpartisan research group in Washington. The Congressional Budget Office forecasts that it would tip the U.S. into recession.

“If the debt ceiling debate was playing with fire, this is playing with nitroglycerin,” Honeywell’s Cote said at the Bloomberg Markets conference. “There’s the opportunity for our government to spark a global recession with how they handle this fiscal cliff.”

Neel Kashkari, head of global equities at Pacific Investment Management Co., expects that Washington will avoid the full impact of the scheduled tax and spending changes by acting after the November election and before the next presidential term begins in January.

Lame Duck Session

“There will likely be a deal during the lame duck session,”Kashkari said, also at the conference. He predicts a compromise that will limit the effect to about $250 billion in 2013. “We are going to avoid recession, but it will be a meaningful drag on the economy.”

Cote also sees a chance that the fiscal cliff will spur Congress and the presidential winner to action -- along with the business community.

Corporate leaders failed to speak up forcefully when debate over the debt ceiling threatened to push the country to default on its debt in the summer of 2011. “We thought it was the normal political baloney that those guys go through.” Those in the executive suite know better this time, according to Cote, and the pressure will grow after the election on Congress and the White House to put the country on a real and reasonable fiscal path.

Source: Bloomberg

Tax credit for hiring "Returning Heroes and Wounded Warriors"

As part of the President's "Jobs" bill endeavor, last week congress passed and the President signed into law the "Returning Heroes Tax Credit" and the "Wounded Warriors Tax Credit". These new tax credits will assist employers that hire "qualified" veterans with a tax break between $2,400 and $9,600 for each qualified veteran hired. The amount of the credit depends, in part, on how long the veteran has been unemployed, and the credit increases to the maximum if the veteran has a qualified service related disability. A tax credit is much better for the employer than a tax deduction. A tax credit reduces your taxes dollar for dollar, whereas a tax deduction only reduces your taxable income.

The goal of the jobs bill is to incent employers to hire the thousands of veterans that have or will be returning from the war. It would be great if the bill reduces the number of veterans on the unemployment line. I'd love to see all veterans gainfully employed after serving our country. Hopefully the next bill will assist other citizens that have been searching for employment as well.

Now for the details of the new tax law.

Employers that hire veterans who have been looking for employment for more than six months may be eligible for a Returning Heroes Tax Credit of up to $5,600 per employee; employers that hire veterans who have been looking for employment for less than six months may be eligible for a credit of up to $2,400 per employee.

Employers that hire veterans with service-connected disabilities who have been looking for employment for more than six months may be eligible for a Wounded Warriors Tax Credit of up to
$9,600 per employee.

Of course both tax credits have strings attached.

1-In addition to the above criteria, the individual must begin after the date the law was passed, November 21, 2011.
2-State workforce agencies must certify that an individual is qualified for the credit.
3-Employers must complete Form 8850 Pre-Screening Notice and Certification no later than 28 days after the date of hire.
4-Other requirements must also be met to qualify for the credit.

This new tax law is meant to be tax neutral, as a number of other laws were changed to increase revenue.

1-Veterans Administration(VA) mortgage applications contain an application fee. These fees were scheduled to be reduced, but the new tax law delays the mortgage application fee.
2-After the year 2013, it will be more difficult to qualify for a health insurance premium assistance tax credit. Health insurance exchange options are scheduled to be available under the Patient Protection and Affordable Care Act.upcoming premium assistance tax credit for qualified individual who obtain health insurance through a heals insurance exchange after 2013

New IRS Inflation Adjustments could help or hurt your cash flow

The IRS recently announced inflation adjustments in the tax code for 2012. IRS statistics report inflation increased just over 3.8%. Obviously, this doesn't take into consideration the rising cost of food and gasoline, as these items have increased much more than that!

For some, the IRS inflation adjustments will result in lower tax burden for 2012. For others, their paycheck will be a little lower than in the past with an increase to the Social Security Wage base.

First the bad news.

Employees and self-employed individuals pay social security taxes on the wages, or profit for self-employed individuals. The maximum wage base subject to this tax increases for 2012 to $110,100 from $106,800. This is the first increase in the wage base since 2009.

Now some good news.
RETIREMENT PLANS
401Ks The maximum amount an individual can contribute tax-free to a 401(k) plan increased to $17,000. If you are 50 years old or more, you can contribute an extra $5,500 to you retirement plan.

Traditional IRAs.. The deduction for taxpayers making contributions to a traditional IRA is phased out for single individuals and heads of households who are covered by a workplace retirement plan and whose modified adjusted gross incomes fall within certain ranges. For 2012, the income phaseout range starts at $58,000 and ends at $68,000, up from $56,000 and $66,000, respectively, for 2011. For married couples filing jointly, in which the spouse who makes the IRA contribution is covered by a workplace retirement plan, the income phaseout range for 2012 starts at $92,000 and ends at $112,000, up from $90,000 and $110,000, respectively, for 2011. For an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the deduction is phased out for 2012 if the couple’s income is between $173,000 and $183,000, up from $169,000 and $179,000, respectively, for 2011.

Roth IRAs. are subject to similar rules. The AGI limit for maximum Roth IRA contributions for a married couple filing a joint return for 2012 is $173,000, an increase of $4,000 from 2011. The AGI limitation for all other taxpayers (other than married taxpayers filing separate returns) increases from $107,000 for 2011 to $110,000 for 2012.

Individual income tax brackets
Although tax rates have not gone down, inflation also impacts the individual income tax rate brackets (which are 10, 15, 25, 28, 33, and 35 percent, respectively, for 2011 and 2012). Indexing of the income tax rate brackets effectively lowers tax bills by including more of an individual’s income in lower brackets.

Standard deduction. Taxpayers who elect not to itemize deductions use the standard deduction amount. The standard deduction increases by $500 for married couples filing a joint return from $11,400 for 2011 to $11,900 for 2012. The standard deduction for single individuals increases from $5,700 for 2011 to $5,950 for 2012.

Personal exemption. Taxpayers may claim a personal exemption deduction (and an exemption deduction for each person they claim as a dependent). The amount of the personal exemption and the dependency exemption increases from $3,700 for 2011 to $3,800 for 2012. The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (2010 Tax Relief Act) repealed the personal exemption phaseout for higher income taxpayers for 2011 and 2012.

Estate tax. The 2010 Tax Relief Act provided that the basic exclusion amount for determining the amount of the unified credit against estate tax for estates of decedents dying after December 31, 2009 is $5 million. The $5 million amount is adjusted for inflation for tax years beginning after December 31, 2011. For 2012, the inflation-adjusted amount is $5,120,000.

Gift tax exclusion. For 2012, you can give up to $13,000 to any person without incurring gift tax. Married couples can gift up to $26,000 tax-free to any person. There is no limit on the number of individuals you can make the $13,000 ($26,000) gift. The $13,000 and $26,000 amounts are unchanged from 2011.

So you have a little ebay business? Do you need to report the income?

On a recent family road trip to visit my brother-in-law in Louisville, KY, my 14 year old daughter was anxiously awaiting payment confirmation for her largest sale-to-date for her ebay business.  Correction, her ebay hobby....

She's been busy generating cash for vacation....  I was a bit amazed that she was able to sell her old camera for $60, plus shipping.  I was even more surprised the buyer paid her extra money to ship it express mail so he would have it in time for his vacation, in Florida of course!

Always the skeptic, I suggested she not mail the camera to the buyer until she had confirmation that his payment was received in her paypal account.  She assured me the buyer had only positive comments in his transaction history, so I figured he was probably legit, but still......About halfway to Louisville, she received confirmation payment was received, so her business transaction went well!

However, it was time for this father to have another uncomfortable conversation with his 14 year old daughter.....this time about taxes.  You see, in order to help narrow the "tax gap" caused by unreported income, the IRS is enforcing a new tax regulation meant to ensure all taxable income is reported.  The new Form 1099-K reports the recipient and amount of credit card sales processed by third party settlement organization, like Visa, Mastercard, American Express and yes, Paypal.  This is sure to trip up many home-based ebay and internet businesses that may not have reported taxable income in the past.

The good news for my daughter is that she will fall under two exeptions from tax reporting requirements.

#1 Since there is no way she will ever sell her "inventory" for more than she(I) paid for it, there will never be any profit from the business.  Unless of course there is ever a resurgence of polularity of beannie babbies, in which case I'll gladdly bring up her tax reporting requirements!  A business in which there will never be profit is considered a hobby in the eyes of the IRS.  Income may need to be reported in certain circumstances, but expenses can never exceed income in order to generate a tax loss.  Disclaimer....other reporting requirments may be required.

#2 The new 1099-K is not required if credit card volume is under $20,000 and 200 transactions during the calendar year.  If she sold all of the "inventory" during the year, she would still be under these thresholds. (wanna buy a beannie babby?)

The hight of Louisville today was a predawn tour of Churchill Downs by my brother-in-law Kevin.  He is an exercise jockey and trained last years Derby winner Supersaver ridden by Calvin Borel.  Saw Calvin breeze by on a new horse this morning. Could be another Derby winner!

Do not respond to IRS Email!

Recently I've received several emails from the IRS alleging Unreported/Underreported Income (Fraud Application).  As a general rule, the IRS does not email information to taxpayers.  Unsolicited emails from the IRS are scams.  Do not go to any link in the emial, reply to the email or even open any emails from the IRS, United States Department of the Treasury, or Internal Revenue Service, unless you have a current tax case, audit or examination in process and have been in personal contact with an agent or representative from the IRS.

Our experience has shown that very few auditors communicate via email during the course of an audit or examination.  However, their initial contact with taxpayers is never via email.

We find ourselves representing clients undergoing IRS or Department of Revenue audits with increasing frequency.  Audits levels are up tremeandously and are anticipated to increase more as the government searches for more cash-flow.  Most new clients that are undergoing audit find it not so successful representing themselves in an audit.  Auditors have an understandable increased workload and pressure to close a case in the most expeditious manner.  Unfortunate for the taxpayer, the most expeditious manner of closing the audit is usually the most beneficial for the IRS, and most clostly for the taxpayer.

If you are undergoing an audit, be aware of your rights as a taxpayer.  Our recommendation is that you assign a CPA power of attorney to communicate with the auditors directly.  This leaves you completely out of direct communication with the auditor.  Clients tend to appreciate the fact that they don't need to personally meet the IRS agent, which aleviates a great amount of stress and anxiety during an audit.

 

A solution to breaking the debt ceiling crisis

As the debt ceiling crisis continues, the question remains as to how our country's credit rating will be impacted, and what will the lingering impact be on the finances and taxes of businesses and individuals.  Raising the debt ceiling is like giving an addict another hit to get him through the night.  If our individual financial house was as dire as the governments, we wouldn't be able to sustain the debt service and operating costs of our households.  It appears the real solution to the problem will require not only change, but a new attitude to debt and spending.

Out of all the possible changes available, I believe Dave Ramsey has the most refreshing and hopeful approach to solving the debt crisis, one family, one business at a time.  It's not a new approach, but rather one that goes back to the beginning of time.  Check out his presentation on the Great Recovery.

I've become a big Dave Ramsey fan this year.  With many many clients stuck in a bad financial place, forced to reduce spending due to reduce income, the approach to debt and finances from generations ago is becoming more practical, and certainly more sustainable.  Dave Ramsey has a healthy perspective on generating positive change in our environment.

It's hard to believe that just a mere generation or two ago, our family members struggled through a major financial hardship of the time known as the Great Depression.  Many lessons on saving and spending were learned by that generation, some lessons passed on to us if we were lucky. 

I recall my grandfather speaking about owning a corner grocery store during the Great Depression.  He struggled with trying to balance financial survival for his family, yet extending credit to families so they could put food on the table, knowing good and well he would never receive payment from his unemployed customers.

Later in life, I recall how proud he was when he would find a good deal on a used car.  His favorite car to buy was a three year old, big 4 door Buick, preferably with 50,000 miles on it.  His perspective was that a car with 50,000 miles on it was perfect because it was "broken in" and had a lot of life left.  I suspect this was a "value" purchase motivated by an awareness of the value of a dollar, formed by the Great Depression.

What a refreshing idea....buying a car for cash.  I think I'll tell my kids about this story tonight.  They'll probably roll their eyes like I did when my grandfather told me the same stories over and over again, but maybe they'll remember it too!

A New Chapter at McCarron CPAs...

     We at McCarron CPAs realize that the current economy prevents small business owners from receiving  adequate bookkeeping services with affordable prices.  The saying goes, "You get what you pay for."  When hiring a bookkeeper, you must be selective in order to achieve quality.  Sometimes we sacrifice quality for price.  Therefore, we have designed an opportunity to provide QuickBooks clients with full charge bookkeeping services in house or at our location at reduced rates.  At McCarron CPAs, our clients come first!

Call Patty today to schedule an appointment for your bookkeeping needs!

407-897-7050