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BRIEFLY:
Illinois CPA Society provides free tax filing services to military personnel
Those involved in a war overseas, whether a service member or family of military personnel, have more on their minds than filing their tax returns. To help ease the tax filing process, the Illinois CPA Society has partnered with the Internal Revenue Service for the fourth consecutive year to offer the Military Service Tax Assistance Project. The program provides free personal income tax return filing services to members of the U.S. Armed Forces and their families.
To qualify for assistance, individuals and their families must meet the following criteria: a current Illinois resident; and a member of the U.S. Armed Forces having served in a combat zone or qualified hazardous duty area, or a spouse of a member in a combat zone; or a member of the U.S. Armed Forces serving in a contingency operation.
For additional information about the Military Service Tax Assistance Project or to request the assistance of a volunteer CPA, visit the Illinois CPA Society's website at
http://www.icpas.org or contact Karen Rosen at 800-993-0393, ext. 227.
A majority believe their financial situation will be better next year than this year
When it comes to the financial future, there is a sense of short-term optimism and long-term concern among U.S. adults. Three in five (60%) say financially, this year is better than last year and slightly higher percentages (64%) say that next year their financial situation will be better and more secure than it is this year. Looking to the future, over half (56%) of adults worry about their financial future more often today than in the past year and 61 percent do not know what their financial needs are going to be in the future. Looking specifically to retirement, almost half (48%) are confident they will have enough money to live as well then as they do now.
These are some of the results of a Harris Poll of 2,021 U.S. adults conducted online between February 23 and 27, 2007 by Harris Interactive. Review the entire poll results at
http://www.harrisinteractive.com/harris_poll/index.asp?PID=738.
Gross receipts tax: wrong way to finance Illinois government
In his recent state of the state address, Illinois Governor Rod Blagojevich proposed a new business gross receipts tax to raise $6 billion for general fund expenses (largely education and health care). While Illinois may need more money for public services, imposing a gross receipts tax to raise revenue is far worse than raising the state's sales or income taxes.
The chief economic problem with gross receipts taxes is the pyramiding nature of the tax. That is, since the tax applies each time a business sells its goods or services, the tax "pyramids" on products as they move through the production process. The longer the production chain, the higher the effective tax rate on the final product.
Thus, a gross receipts tax badly distorts and interferes with business investment decisions, leading to lower economic growth and job growth. Sales, income and property taxes do not have the same tax pyramiding feature, making them more economically efficient taxes. A $6 billion increase in any of those taxes would cause far less economic harm than a gross receipts tax that raises the same amount of revenue.
Governor Blagojevich, undoubtedly aware of the problems of gross receipts taxes due to a report we released on them, will apparently try to fix the tax by:
- providing a lower tax rate for manufacturers, wholesalers and retailers — industries that will suffer from the pyramiding nature of the tax; and
- exempting companies with less than $1 million in gross receipts from the tax altogether.
These "fixes" are, of course, acknowledgments of the flawed nature of gross receipts taxes. These fixes also narrow the base of the tax and increase the rate needed to raise revenues, moves which contrast sharply with those who claim that a gross receipts tax would be good because it is a low-rate, broad-based tax.
Incidentally, the claim that a gross receipts tax is good because it is "broad-based" is completely refuted by Professor John Mikesell in this study we co-published with the Council on State Taxation.
We are particularly interested in whether Blagojevich (like Ohio two years ago) will adopt the so-called "economic nexus" theory to require out-of-state firms to pay the gross receipts tax on their Illinois sales. If he does so, Illinois companies would likely face an across the board increase in the cost of their purchases, making Illinois a more expensive (and less competitive) place to run a business.
As more details come out, we will offer more analysis and commentary. It is fair to say, however, that a new gross receipts tax that raises $6 billion in tax revenue will have a significant (and negative) impact on Illinois' rankings in our state and local tax burdens (currently 14th worst) and State Business Tax Climate Index (currently 25th worst).
Author Chris Atkins is staff attorney for the Tax Foundation, where he specializes in analyzing federal, state and international tax policy from a legal and economic perspective, and his work often focuses on corporate tax policy. Source: the Tax Foundation,
http://www.taxfoundation.org.
Listen to a podcast from the Tax Foundation on the reemergence of gross receipts taxes . . .
How do they damage certain businesses, and who ultimately ends up paying them? In this podcast, John Mikesell, Professor of Public Finance and Policy Analysis at Indiana University, discusses these problematic taxes, their recent reemergence in state finance, the damage they inflict on businesses, and their lack of transparency. (12 minutes, 35 seconds). Go to:
http://www.taxfoundation.org/podcast/show/2143.html
Newly extended R&D tax credit offers additional benefits
In late 2006, Congress revived a key research and development tax credit that will deliver an estimated $16 billion in savings to U.S. businesses over the next decade.
The latest extension to the 25-year-old R&D credit, which had expired December 31, 2005, was made retroactive to January 1, 2006. It passed with help from a vigorous push by lobbyists in industries ranging from biotechnology to software development. While it will remain in force through 2007, advocates say the patchwork approach to tax policy puts U.S. companies at a competitive disadvantage.
"At least ten nations around the world offer more generous R&D incentives that are permanently written into the tax codes of those countries," says Monica McGuire, senior director for tax policy at the National Association of Manufacturers in Washington, D.C.
Qualifying for the credit
In short, the R&D credit helps ease the financial burden on businesses investing in the development of new or improved products, processes, formulas, software or other technical operations. However, to qualify for the credit, a company's research efforts must meet the following four requirements:
Permitted purpose. The activity must relate to a new or improved business component's function, performance, reliability and quality. A new product or process counts as a business component.
Elimination of uncertainty. The intent of the activity must be to discover information to eliminate uncertainty concerning the capability or method for developing or improving a product or process, or the appropriateness of product design.
Technological in nature. This step is pretty clear-cut: Qualifying research must be rooted in the physical sciences such as biology or chemistry, or in defined technology areas such as engineering and computer science.
Process of experimentation. Substantially all of the activity must be part of a process of experimentation involving:
- evaluation of alternatives;
- confirmation of hypotheses through trial and error, testing, or modeling; and
- refining or discarding of a hypotheses.
Once an activity qualifies for the research credit, the research expenses are determined. Eligible expenditures include W-2 wages for employees, supplies and 65 percent of fees paid to outside consultants.
In recent years, about 75 percent of U.S. companies applying for the R&D credit were in the manufacturing sector. Experts say small to midsized players in that segment benefit most from the credit, largely because innovation investments in those firms can more visibly dampen profitability.
Broadening R&D credit appeal
The traditional method for calculating the R&D credit requires an established company to document its research spending from 1984 to 1988 to determine a base amount. A company may claim an R&D tax credit on 20 percent of expenses over the base amount or 50 percent of qualifying research expenses, whichever is higher. Taxpaying companies that didn't exist during the 1984 to 1988 timeframe or which didn't have three years of qualified research and gross receipts during that period use separate start-up company rules.
Companies must add the credit to taxable income or elect to claim a reduced credit of 13 percent.
Companies may elect to calculate the alternative incremental credit (AIC), which provides businesses with a tax credit as long as qualified R&D expenses exceed one percent or more of the company's gross annual receipts. Recent legislation increases the credits beginning in 2007 to:
- three percent (an increase from 2.65 percent) of qualified research expenses greater than one percent and less than 1.5 percent of average annual gross receipts;
- four percent (an increase from 3.2 percent) of qualified research expenses greater than 1.5 percent and less than two percent of average annual gross receipts; and
- five percent (an increase from 3.75 percent) of qualified research expenses exceeding two percent of average annual gross receipts.
A second key change in 2007 is the introduction of an alternative simplified credit. This method allows businesses to total qualifying R&D spending for the current year and compare it with R&D expenses over the preceding three years. If current qualified R&D spending is more than 50 percent of the average for the past three years, the company may claim a 12 percent tax credit. If there were no qualified expenses in that prior three-year period, the company still can claim a six percent credit on qualifying R&D expenses.
"This was the biggest change in the R&D credit in over ten years," McGuire says. "While the alternative simplified credit will be beneficial to some large companies, it really helps small and midsized companies, because it eliminates that fixed base period in favor of a rolling base over a more recent period of time."
Can your company benefit from the newly extended R&D tax credit? If so, experts suggest a few quick tips to help smooth the process:
Do your homework. Applying for the R&D credit involves more than crunching numbers. It also means working with your technical personnel to build documentation that your research projects meet the four-part test. If in doubt, consult with a trusted third party experienced in developing support for the R&D credit.
Review open tax years. Because R&D tax credit extension passed late in 2006, many C corporations on a calendar year had to scramble to make an initial tax filing deadline of March 15, 2007. However, tax experts say business leaders who need more time to document their research work can file for a six-month extension on their corporate tax submission. Additionally, your company can take this opportunity to file for the most recent R&D credit as well as for any past credits to which your business may be entitled.
IRS guidelines for retaining tax returns
IRS Publication 583, Starting a Business and Keeping Records, offers the following guidelines for retaining tax-related documents, regardless of what form they are in.
1. Tax returns (including supporting documentation)
Keep for three years from the date the return was filed or when the tax was paid, whichever is later, unless 2, 3 or 4 below apply.
2. Tax returns where gross income is underreported by 25 percent or more.
Keep for six years from when the return was filed or when the tax was paid, whichever is later.
3. A fraudulently filed tax return.
Keep indefinitely
4. Amended tax return or claim for a credit or refund.
Keep for the later of three years from when the original return was filed or two years from when the original tax was paid.
5. A tax return showing a loss from a worthless security or bad debt deduction.
Keep for seven years from the date the return was filed.
6. Employment tax records (if you have employees)
Four years from when the taxes were due or when they were paid, whichever is later.
IRS offers tips for accurate Schedule K-1 reporting
Income, deductions and credits from partnerships, S corporations, estates and trusts are reported to investors on Schedules K-1. Correct information on the forms by issuers and reporting of the income by recipients is important because the IRS matches the data to other tax returns to ensure accurate reporting.
A recent study found that many unnecessary notices issued to taxpayers could have been avoided if Schedule K-1 entity information was accurate when the forms were filed and if offsets against income reported on Schedule K-1 were reported correctly.
Businesses, individuals and return preparers can avoid unnecessary questions and correspondence by following these instructions:
For flow-through entities issuing Schedules K-1 — Ensure entity information on Schedules K-1 properly identifies the taxpayer (or other entity) responsible for reporting the Schedule K-1 income.
For recipients of Schedules K-1 — Avoid netting or combining income against losses or expenses not reported on Form 8582, Passive Activity Loss Limitations. Refer to the instructions for Form 8582 on how to properly report passive activity losses. Ordinary business income should be reported separately from related deductions, such as unreimbursed partnership expenses or the Section 179 expense deduction. Refer to the Schedule E instructions for information on properly accounting for deductions related to Schedule K-1 income.
For example, unreimbursed partnership expenses from nonpassive activities should be entered on a separate line in column (h) of Schedule E's line 28 and labeled "UPE" in column (a) of the same line. Do not combine these expenses or net them against any other amounts from the partnership.
To reduce errors, the IRS also encourages electronic filing of Schedules K-1 and other tax forms.
Provisions are a solution in search of a problem
In testimony on March 14, 2007, before the U.S. House Ways and Means Committee, a representative of the National Association of Manufacturers (NAM) urged House tax-writers to avoid imposing new taxes on manufacturers, making it more difficult for them to compete in the global marketplace.
At the hearing — which focused on revenue-raisers in the Senate-passed minimum wage bill — Ken Petrini, vice president of taxes at Air Products and Chemicals, Inc and chairman of the NAM's Tax and Budget Policy Committee warned of the potential impact of "overly broad" provisions "that threaten to ensnare transactions and expenses well beyond their intended scope."
Noting that manufacturers currently face some of the highest legal costs in the world, Petrini told the Committee that "proposals to eliminate tax deductions for punitive damages and settlements of potential violations of law will only increase the cost of doing business in the United States. American consumers and businesses would lose if the provisions on punitive damages and settlements are adopted."
Petrini also raised objections to new proposed limits on nonqualified deferred compensation plans, which are used by manufacturers to align worker and management interests. "The proposal, which is not targeted at any abuse of deferred compensation, is a solution in search of a problem that would effectively eliminate the ability of employees to use deferred compensation as a retention tool," he said.
Turning to another Senate proposal that would de-link securities law from the tax code with regard to the deduction and disclosure of executive compensation, Petrini noted that "this change would create unintended ambiguities in the law because of the different definitions used by the SEC and IRS. Keeping the securities laws and the tax code linked will allow for easier administration of salary deduction allowances and compensation disclosures.
"NAM members strongly believe that tax relief will go a long way to ensure continued economic growth," Petrini said. "In contrast, revenue raisers, like the ones discussed today, will negate much of the positive impact of tax relief."
Governor's budget proposal includes three percent payroll tax on employers
In addition to the $6 billion GRT tax, the Governor also included a three percent payroll tax on the business community to fund his universal health care program. Entitled "Illinois Covered" the proposal seeks to extend free or subsidized health care to the approximately 1.6 million Illinoisans who are currently uninsured. The Governor anticipates that the new health care plan will cost $374 million in FY08 but will skyrocket to nearly $4 billion within three years.
The universal health care program exempts businesses with less than 10 employees and provides a dollar-for-dollar income tax credit for companies that provide health care benefits to their employees.
While the vast majority (98 percent) of manufacturers understand the importance of health care and provide health insurance to their employees, this plan seems to create more problems and questions that must be addressed. Illinois Covered does not address the skyrocketing cost of health care and seems to mandate a new level of coverage. While access to affordable health care is important to the well-being of Illinois employers and workers, many questions remain about whether the new revenue will cover Medicaid expansion and whether the business community who already provide health care should be expected to "finance" the cost of the program.
Important Tax Filing Deadlines
April 16, 2007
- 2006 Individual Income Taxes Due
- 2007 Q1 Estimated Taxes Due
The Electronic Federal Tax Payment System (EFTPS) — a secure way to pay all your Federal taxes
EFTPS is a tax payment system provided free by the U.S. Department of Treasury. Pay federal taxes electronically — on-line or by phone 24/7. Visit http://www.eftps.gov/ to enroll.
Businesses and Individuals can pay all their federal taxes using EFTPS. Individuals can pay their quarterly 1040ES estimated taxes electronically using EFTPS, and they can make payments weekly, monthly, or quarterly as well as schedule payments for the entire year in advance.
More than 7 million taxpayers are currently enrolled in the system.
"Truthy" claims about gross receipts taxes
Supporters of Illinois Governor Blagojevich's gross receipts tax have floated claims that have an air of "truthiness" about them. Here we analyze a number of those claims:
Truthy claim: gross receipt taxes (GRT) are low rate taxes.
Maybe. There is nothing inherent about gross receipts taxes that make their rates low. The statutory rates are set based on the revenue lawmakers want to raise. If enacted, the proposed statutory rate in Illinois would be the highest GRT rate in the country.
Truthy claim: A GRT's broad base is more economically sound than other tax bases.
Wrong. Though a broader tax base is generally preferable to a narrow one, the GRT base is economically irrational. In many cases, the GRT base can exceed the state's entire final economic output. Broad coverage of a reasonable base, not broad coverage alone, is the proper standard. If broad coverage alone were the standard, a tax on grains of sand, blades of grass, or people named Smith would make the most sense.
Truthy claim: A GRT does not discriminate.
Flat out false. GRTs heavily discriminate based on business structure. The effective tax rate for a business depends on the nature of the industry and the length of the production chain. This discrimination gives companies an artificial incentive to vertically integrate, take on responsibilities that make production less efficient, or seek to avoid the tax.
Truthy claim: GRTs close corporate loopholes.
False. There is nothing about a GRT structure that prevents lawmakers from writing loopholes into the law. Indeed, even the Illinois Governor's own GRT plan already includes some loopholes, special rates, exemptions, etc. Corporate loopholes can be closed without imposing a gross receipts tax.
Truthy claim: GRT is a "new" tax.
Only if Leonardo da Vinci is considered a "new" artist! GRTs date back to the thirteenth century in Europe. They first reared their ugly head in the U.S. by the mid-1800s.
Truthy claim: GRTs work in other states.
If by "work" you mean create a host of complex problems that have to be addressed year after year, then sure. Washington State has had a GRT since 1933 and they are routinely heading back to the drawing board. Research indicates that GRTs do not appear to contribute to the overall stability of a state tax system.
Truthy claim: GRTs grow with the economy.
So does every other tax. This is like using "wetness" to compare tap water to bottled water.
Truthy claim: GRTs are sound tax policy.
Actually, they are one of the worst tax systems ever created. GRTs are irrationally broad; create effective tax rates that vary depending on the industry; show no effect on revenue stability; distort the market through "pyramiding"; make businesses less competitive; and hide the true cost of the tax from the individuals who pay it.
Co-author Chris Atkins is staff attorney for the Tax Foundation, where he specializes in analyzing federal, state and international tax policy from a legal and economic perspective.
Co-author Brian Phillips is the manager of media relations at the Tax Foundation.
Source: the Tax Foundation, www.taxfoundation.org.
Attracting business with honey: business-friendly states see rapid growth
(The following article originally appeared in the October 11, 2006 edition of the
Edmond Sun.)
Here's a piece of free advice for every candidate running for state office this year: Make your state's business tax climate more competitive and economic growth will follow.
A new report by The Tax Foundation, which ranks the business tax climate of all 50 states, known as the 2007 State Business Tax Climate Index, reveals that states with the most competitive business climates consistently have faster growth rates in population, employment, output and personal income than states ranking poorly.
In fact, between 2000 and 2005, income in the top 10 states in the 2007 Index grew 44 percent faster than in the bottom 10 states. Employment in the top 10 states grew 115 percent faster, output 52 percent faster and population 164 percent faster.
It is commonly argued that more economically developed states like New Jersey and New York have slower growth rates because their economic indicators, such as population and median income, are so much higher than those of developing states. Texas, however, debunks the myth that economically developed states do not have room to grow.
One of the largest states in the union in both population and output, Texas comes in seventh in population growth, 11th in output growth, and 17th in increasing personal income. While its big-state brethren lag far behind, Texas remains near the top by embracing favorable conditions for businesses such as the absence of a state income tax.
Size is no excuse. State tax systems that are simple, fair, broad-based and low-rate can experience significant growth regardless of size or level of economic development.
The speed at which labor and capital can relocate increases exponentially every day. A T-shirt shop or bookstore no longer needs to be located near a large market in order to do business there. If economically developed states like Rhode Island, New Jersey, Ohio, New York and California are unable to make their tax systems more competitive and business-friendly in the modern market, the states that score well on the Index will rapidly close the gap.
We can see this trend clearly by looking at the labor force growth rates of highly competitive states that neighbor those with poor business tax climates. Since the beginning of 2004, the average labor force in each state has grown by about three percent nationwide.
However, California, with its punitive business tax climate, saw only a two percent growth in labor, while its more business-friendly neighbors, Nevada and Arizona, doubled and tripled the national average, respectively.
While taxes are among the many considerations in business location decisions, an attractive tax climate is a relatively simple way for a state to set itself apart from the pack. Promises of increased funding for education, infrastructure improvements and tougher crime laws — even if realized — can take years, if not decades, to have any effect. But making a state's business tax climate more competitive will have an immediate impact. The research shows modest improvements in a state's business tax climate can produce rapid growth in income, output, employment and population.
Taxes are by no means the only factor that contributes to economic growth, but the data are hard to ignore. With state coffers filled to the brims, state officials have the opportunity right now to mitigate the transition pains of changing their tax systems, and thereby improve their state's business tax climate for years to come.
Authors Curtis Dubay and Brian Phillips are with the Tax Foundation in Washington, D.C. The 2007 State Business Climate Index is available at
http://www.taxfoundation.org/publications/show/78.html.
Source: the Tax Foundation, http://www.taxfoundation.org.
Tax Policy Memo is published quarterly for IMA members by the Illinois Manufacturers' Association,1211 W. 22nd St., Ste. 620, Oak Brook, IL 60523, (630) 368-5300.
Editor: Stefany Henson, Director of Publications (shenson@ima-net.org).
Reproduction of all or any part is prohibited except by permission of authorized IMA personnel.
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