Fashion designer Georges Marciano left his native Marseilles with his brothers Armand, Paul, and Maurice in 1977, and founded Guess? jeans in 1981. Guess? helped popularize the stonewashed denim look, and gained fame with a series of iconic black-and-white ads featuring supermodels Claudia Schiffer, Eva Herzigova, and Laetitia Casta. Marciano built on that initial success with designer jeans by expanding into watches and accessories, footwear, menswear, bedding, and fragrances.

Unfortunately, Marciano’s eye for business never matched his eye for fashion. In the 1980s and early 1990s, Guess? fought allegations of sweatshop labor, which led to a $573,000 settlement. And in 2005, they were forced to apologize after releasing a line of t-shirts glamorizing the drug trade that proudly declared “Ski Colombia: Always Plenty of Fresh Powder.”

Also in 2005, Marciano claims he uncovered evidence of identity theft, fraud, and embezzlement, that he said cost him nearly $200 million. He did exactly what you would do if you were missing that much money — he sued everyone in sight. But somewhere along the line, he started worrying that he owed tax on the stolen money. So in 2008, he wrote the IRS and asked them to audit him! You would think they would be happy to oblige. But Marciano claims they stonewalled his requests, and even sent him refunds totaling $880,997.17 based on a claim for a tentative carry-back that Marciano says he never made!

Meanwhile, Marciano’s former accountants won judgments against him for libel and intentional infliction of emotional distress, and his creditors forced him into involuntary bankruptcy. So in a last-ditch effort, Marciano filed suit in U.S. District Court, seeking relief from the state court judgments against him, arguing that the IRS had violated his rights (including his due process rights under the Constitution), and once again demanding a “thorough” audit of his tax liabilities.

Last month, Judge Henry Kennedy, Jr., threw out Marciano’s case like last season’s closeouts. “The extraction by the government of money or property via taxation implicates a constitutionally protected property interest, but, as noted above, Marciano has asserted repeatedly that he owes the government money, rather than the reverse,” Kennedy wrote. “The Court is aware of no precedent establishing a protected property interest in the ability to pay taxes.”

If you ever ask us to sue the IRS to audit you, we’ll probably tell you to take a seat and make yourself comfortable while we find you some aspirin, or scotch, or maybe a straitjacket!

What do you think? Does Marciano really think he owes tax on $200 million? Or is he just asking the IRS to clean up his accounting mess for him?

For the first fourscore and seven years of our history, we relied on tariffs to finance the government. Things started heading downhill in 1862, when President Lincoln signed the first income tax law to help pay Civil War expenses. The tax itself was 3% on incomes above $600 (roughly $13,000 in today’s dollars) and 5% on incomes above $10,000 ($212,000 in today’s dollars). Lincoln also appointed the first Commissioner of Internal Revenue. Clearly this is why more states celebrate Washington’s birthday than Lincoln’s.

Lincoln’s tax was repealed in 1872, and for the next 40 years, the government raised 90% of its revenue from taxes on alcohol and tobacco. In 1909, President Taft proposed a constitutional amendment authorizing the government to impose income taxes without apportioning the burden according to state populations. Four years later, New Mexico became the crucial 36th state to ratify what became the 16th Amendment. Later that year, president Woodrow Wilson signed the Revenue Act of 1913, which imposed a progressive tax starting at 1% on incomes above $3,000 (roughly $66,000 in today’s dollars) and topping out at 7% on incomes over $500,000 (a whopping $11 million in today’s dollars). Wilson’s administration also introduced the first Form 1040 — which probably explains why there’s never been a national holiday for Wilson’s birthday!

World War II forced Washington to raise taxes to unprecedented heights. So naturally, President Franklin Roosevelt presided over some important changes in tax policy. He signed the Revenue Act of 1942, which imposed a 19% tax on the first dollar of taxable income (!) and raised the top rate to 90% on incomes over $200,000. (On a brighter note, it created new deductions for medical expenses and investment expenses.) In 1943, he signed the Current Tax Payment Act, which imposed withholding. And in 1944, he signed the Individual Income Tax Act, which created the first standard deduction on Form 1040.

Top marginal tax rates remained at 70% for the next 30 years, as deductions, shelters, and loopholes proliferated like bad movie sequels. In 1976, candidate Jimmy Carter declared the income tax “a disgrace to the human race.” As President, he signed the Tax Reduction and Simplification Act of 1977, which replaced the old percentage standard deduction with a fixed amount ($3,200 for joint filers, or roughly $10,000 in today’s dollars). A year later, he signed the Revenue Act of 1978, which cut tax rates, cut the number of brackets, and established the first flexible spending accounts.

A decade later, President Reagan signed the Tax Reform Act of 1986. This once-in-a-generation law drastically cut the number of tax deductions, the number of tax brackets, and actual tax rates. At the same time, the law extended the Alternative Minimum Tax and created a new category of “passive income” that killed most of the old-school tax shelters. While later Presidents raised rates and expanded the number of brackets, the ’86 tax act remains the foundation for today’s tax system.

Are you looking for one President to blame for the monster that we know as the Tax Code? That’s too easy, they all are. But we can help you with the hard stuff like protecting you from the system they’ve all created. As this year’s tax filing deadline approaches, don’t hesitate to let your friends, family, and colleagues know that we’re here to protect them too!

Everyone knows that it took the IRS to finally put Capone behind bars. But how did it all go down? How much tax did Capone really evade? Back in 2008, the IRS released several documents relating to the case, and they reveal a fascinating glimpse into the investigation that brought down “Public Enemy Number One.”

It all started in 1927, when the U.S. Supreme Court held that a bootlegger named Manny Sullivan owed tax on his illegal income. Two years later, President Hoover and Treasury Secretary Mellon vowed to put Capone behind bars. The Treasury Department’s Special Intelligence Unit assigned IRS Special Agent Frank Wilson to the case. Wilson spent three years investigating Capone and even infiltrating “the Outfit” with federal agents in order to determine Capone’s income. His big break came when he found three ledgers that had been seized in a gambling raid in Cicero — then from there, traced the handwriting in the ledgers to a deposit slip from a bank in Cicero — then from there, traced the deposit slips all the way to a bookkeeper at a dog track in Miami who ultimately agreed to testify. (Wilson made further history during the Lindbergh baby kidnapping — his bright idea to record the serial numbers on the gold certificates paid as ransom helped secure kidnapper Bruno Hauptmann’s arrest and became common practice in kidnapping cases.)

Wilson’s investigators calculated that, from 1924-1929, Capone’s share of the Outfit’s earnings from “gambling, houses of prostitution, and bootlegging” totaled $1,055,375.07. (That’s about $13 million in today’s dollars.) The IRS hit him with $219,260.12 in tax and threw in another $164,445.09 in penalties.

A federal grand jury indicted Capone on 22 counts, including “failure to file returns” (a misdemeanor) and “willful attempt to evade and defeat an income tax” (a felony). Capone originally copped to all charges, but when he discovered the judge wouldn’t be bound by the prosecution’s sentencing recommendations, he switched his plea to “not guilty.” After a long trial that included an unsuccessful plot to bribe potential jurors, Capone was convicted, sentenced to eleven years, and fined $250,000 plus $30,000 in court costs.

Capone wasn’t the only Chicago mobster who wound up answering to the IRS. The Service also won convictions against Capone associates Jake “Greasy” Guzik and Frank “the Enforcer” Nitti, among others. And the convictions inspired still more delinquent taxpayers to come forward and ‘fess up, including one “big shot gambler” who showed up at the IRS’s Chicago office to pay $200,000 in cash!

Capone’s conviction broke his hold on the Chicago outfit. He spent seven years as a guest of the federal government, including four years at Alcatraz, before winning parole and returning to his home in Florida, where he died in 1947. The infamous garage where the Saint Valentine’s Day Massacre took place is now a parking lot. It’s ironic that Capone’s greatest legacy may be a Valentine to the IRS, in the form of reminding gangsters of all stripes to pay their taxes!

The day before the game, the Wall Street Journal weighed in with the kind of observation you’d expect them to make — specifically, that “the Steelers will get to keep a lot more of their season earnings, though both team’s players would be a lot richer if they played all their home games in Dallas.”

The difference, of course, is taxes. Super Bowl MVP Aaron Rodgers and his Packer teammates play their games in Green Bay, where they pay Wisconsin state taxes of 7.75% on income over $220,000. (Since the minimum NFL salary is $310,000, that means every Packer pays the top rate.) The AFC champion Steelers play in Pittsburgh, where they pay Pennsylvania state taxes of just 3%. That difference may not look like much, but it adds up fast. Green Bay’s Rogers made $8.6 million last year, paying an estimated $3.1 million in federal income and payroll tax and $680,000 in state income tax. He would have saved $398,050 in state tax if he played in Pennsylvania. That’s a lot of cheese!

Many states and municipalities have started collecting income taxes from visiting athletes and other performers. This can lead to complicated calculations to avoid double taxation. For example, if this weekend’s big game had been played in Pittsburgh, Packers would have paid state tax of 3% of their gameday pay and taken a credit for that same amount against their Wisconsin tax. If the game had been played on the frozen tundra of Lambeau Field, the visiting Steelers would have paid Wisconsin tax on top of their regular Pennsylvania tax!

But Texas, is one of seven states with no individual income tax whatsoever. Of course, the Super Bowl itself brought millions to Dallas as the host city, even after accounting for last week’s unexpected winter blast. If Texas officials had tried to tax the visiting players, on top of that economic windfall, the refs would have done well to call them for unsportsmanlike conduct!

That’s probably not much comfort to the members of the 6-10 Houston Texans and 6-10 Dallas Cowboys, most of whom would probably trade state taxes for a few more Ws! (In fairness, however, Saturday’s Journal piece points out that Texas taxes beer at twice the rate of Wisconsin or Pennsylvania.)

Stock market forecasters swear by the so-called “Super Bowl indicator,” which holds that when a team from the old National Football League (now today’s NFC) wins the Super Bowl, it means a good year for stocks. But can state income tax rates help predict Super Bowl winners? This year, the high-tax Packers beat the low-tax Steelers. Last year, the higher-tax New Orleans Saints beat the lower-tax Indianapolis Colts. But in 2009, the lower-tax Steelers beat the higher-tax Arizona Cardinals. And in 2008, the high-tax New York Giants beat the lower-taxed New England Patriots. So don’t bother checking tax rates before entering your Super Bowl pool!

The lesson for us is that we tend to focus on federal income tax — for most of us, it’s as obvious as an opponent’s defenders looming large at the line of scrimmage. But we can’t forget state and local taxes, hiding in the backfield like a defensive secondary. So think of us as your financial offensive line, protecting you from all tax threats. And don’t worry, football diehards, the NFL pre-season starts in just six months, if the players don’t strike!

Back in the 1993 film Groundhog Day, Bill Murray starred as weatherman Phil Connors, sent to Puxsutawney to cover the festivities. That night, a blizzard hits, forcing Phil to overnight in town. He wakes up the next morning to find it’s February 2 again, his day unfolding exactly like the day before. Ultimately he realizes he’s doomed to live the same day forever — even by killing himself he can’t break the cycle.

Since then, Groundhog Day has become cultural shorthand for living the same events over and over. So, what does that have to do with taxes? Well, last week President Obama delivered his second State of the Union address — and his comments sounded depressingly familiar to those of us who follow tax policy: 

• First, he called on Democrats and Republicans to simplify the corporate tax system. “Get rid of the loopholes. Level the playing field. And use the savings to lower the corporate tax rate for the first time in 25 years — without adding to our deficit.”
• Next, he declared that “the best thing we could do on taxes for all Americans is to simplify the individual tax code. This will be a tough job, but members of both parties have expressed interest in doing this, and I am prepared to join them.”
• Finally, he stated that “if we truly care about our deficit, we simply cannot afford a permanent extension of the tax cuts for the wealthiest 2% of Americans. Before we take money away from our schools, or scholarships away from our students, we should ask millionaires to give up their tax break.”

Most Americans think tax simplification is a great idea. The problem, of course, is that hearing calls for tax simplification is like waking up to the same Groundhog Day over and over again. Lawmakers from both parties have sparred over corporate taxes since before former President Reagan offhandedly proposed eliminating them decades ago. They’ve floated endless plans to simplify personal taxes. And they fought all year over extending the Bush tax cuts to the top 2% of earners — right up until extending them temporarily just a few short weeks ago.

Bill Murray was the perfect choice to make Groundhog Day into a hit comedy. If Hollywood made April 15 into a movie, they’d look for someone like Wes Craven or Rob Zombie to make it! But you don’t have to wait for lawmakers to see their shadow before you can cut your taxes. The real key to minimizing that tax bill is planning. Most tax professionals do a fine job recording history. But we’re here to help you write it, with a full menu of deductions, credits, loopholes, and strategies. Punxsutawney Phil predicts you’ll love the savings!

Internal Revenue Code Section 105 (which excludes employer-paid health insurance and other benefits from your taxable income) and Section 213 (which lets you deduct your medical and dental expenses) have both been law since 1954. You would think, after all those years, the topic of “medical deductions” would be pretty settled. But you might be surprised to learn just how much taxpayers and the IRS clash over the limits of medical deductions. So as we head into cold and flu season, let’s take a look at some of the more intriguing recent developments in medical deductions:
 

• The IRS denied a request from the American Academy of Pediatrics to make breast-feeding costs a deductible medical expense. Although one study found that antibodies passed from mother to child could prevent the premature deaths of up to 900 babies per year, the IRS considers breast milk to be “nutrition” rather than “medicine.”
• The IRS issued an opinion stating that the cost of an “herb” may be a deductible medical expense if: (1) the taxpayer can substantiate that they have a medical condition, (2) they’re purchasing the herb to treat or alleviate that condition, and (3) and they wouldn’t have bought the herb “but for” that condition. However, the IRS still says no to deductions for medical marijuana — even when prescribed by a state-licensed physician — because marijuana remains illegal under federal law.
• Would you believe that sex change surgery is a deductible expense? The Tax Court just issued a 139-page opinion ruling that gender identity disorder is a “disease” under Code Sections 213(d)(1)(A) & (9)(B) and the taxpayer’s hormone therapy and surgery were for “treatment” of that disease under those same sections. But in the same case, the Court also ruled that the taxpayer’s breast augmentation was merely directed at improving her appearance and thus qualified as nondeductible “cosmetic surgery” under Code Section 213(d)(9)(a).
• Finally, the Tax Court shot down deductions for $108,086 in visits to prostitutes and $7,373 in pornographic books, magazines, and other materials. The taxpayer, a 77-year-old tax attorney (I know, Ripley’s didn’t believe it either), argued they were reasonable expenses to fight depression and erectile dysfunction brought on by age. The Court noted that: (1) none of those expenses were incurred as part of any course of therapy prescribed by a doctor, (2) patronizing prostitutes is illegal in New York, and (3) he should have known better!

Medical expenses in general are getting harder to deduct. Last year’s healthcare reform raises the threshold for deducting medical and dental expenses, effective 2013, from 7.5% to 10% of adjusted gross income. (If you’re self-employed or buying your own insurance, ask us if a Medical Expense Reimbursement Plan or Health Savings Account might help avoid those limits entirely!)

Now let’s sew this all up. If your doctor told you you needed surgery, you’d ask for a second opinion, right? Well, the IRS performs surgery every day — they remove cash from your wallet — and they don’t use anesthesia! So if you’re not already doing business with us, and you’d like a second opinion on your taxes, call us! If you already are doing business with us, and you have friends, family, or colleagues who are business owners and would like that second opinion, send them our way!

Riding a seven game winning streak (at least as of this writing), it looks like if the “dream team” of James, Dwayne Wade, and Chris Bosh have a real chance of delivering the NBA championship James seeks. But everyone thinks the superstar’s move was all about the championship ring—but we know the real reason, and if you’re reading about it here, you’ve probably already figured out it has to do with taxes.

The state of Ohio imposes a top income tax rate of about 7%. The state of Florida imposes . . . well, no income tax. James’ salary hasn’t been disclosed. But, assuming he makes $100 million over the next five years, he’ll avoid state tax on at least half of that income. (Professional athletes typically pay state and local taxes for dates they play away games in locations with income tax.) At 7%, that figures to save him $3.5 million or more over that period.

The Heat’s low-tax environment looks good compared to the 7% tax James paid in Ohio. It looks even better next to a couple of other teams that courted him. Had he gone to the New Jersey Nets, he would have faced a 9% tax. And had he gone to the New York Knicks, his combined state and city taxes would have reached a whopping 12.85%! That’s a lot of three-pointers!

Oh, and don’t forget the tax he’ll save on endorsements! Since signing with Nike, James has added deals with Sprite, Glaceau water, Bubblicious, Upper Deck, McDonalds, and even State Farm Insurance. Those deals may ultimately “net” him more than his actual playing salary.

You’re probably not planning to move cross-country to save state tax. But if you are looking to relocate or perhaps retire somewhere else, be sure to consider how taxes affect your move. We can help you create the plan you need to save taxes here or away. Just call us to “tip off” your plan!

That’s right, our own beloved Uncle Sam is arguably as guilty of “cooking the books” as any corporate scamster. In fact, if he were running a publicly-traded company the way he’s running the government, he’d likely be serving time in one of his own prisons!

Here’s the issue. Most of us use what’s called the “cash” method of accounting. It’s pretty simple, really. Cash comes in, cash goes out, and at the end of the year there’s a difference we call “profit” or “loss.” In Washington, they call those year-end results “surplus” or “deficit.” For fiscal 2010, that deficit was $1.3 trillion, and our total national debt now stands at $13.9 trillion (give or take a few billion).

But publicly-traded companies and bigger privately-held businesses are required to use the “accrual” method of accounting. That method requires them to recognize income and expenses when incurred, rather than actually paid. It’s kind of like recognizing you owe 30 years of mortgage payments the day you buy your house. And according to the 268-page Financial Report of the U.S. Government (the closest thing we have to a federal “balance sheet”), if Uncle Sam used the accrual method, the government’s “net operating cost” for 2010 soars all the way to $2.1 trillion!

Social Security is the classic example of “off books” federal accounting. Actuaries estimate that over the next 75 years, the system will spend $8 trillion more in benefits than it takes in from payroll taxes and interest on the Social Security “trust fund.” And Uncle Sam owes even more for unfunded promises like future Medicare benefits ($23 trillion), retirement benefits for federal employees and veterans ($5.7 trillion), environmental cleanup costs ($300 billion), and loan guarantees related to Fannie Mae and Freddie Mac ($600 billion). Those trillion-dollar promises are certainly part of the federal debt. But you won’t find them listed in any official balance sheet!

What does this all have to do with taxes? Well, regardless of how we calculate the federal debt, there’s only one way to eliminate it. At some point, the government is going to have spend less than it makes. And that’s going to mean higher taxes. If you’re dreading the tax hikes necessary to close a $1.3 trillion deficit, just imagine what you’ll need to pay to eliminate $2.1 trillion!

That’s why, as we begin this new year, we’re focusing more of our practice on tax planning. If we’re going to deliver the most value possible, it’s not enough just to look at your finances in relation to where taxes are now. We have to look at them them in relation to where taxes are going to be. So look to us for more than “just” a tax return this year. And remember, if you have friends, family or colleagues that own small businesses, we can prepare Tax Plans for them too!

The new law is surprisingly direct and straightforward, given its $850 billion cost. Major tax bills are typically thick enough that you can stand on them to change a light bulb. But this one clocks in at just 30 pages — in fact, the Congressional Joint Committee on Taxation’s “Technical Explanation” is five times longer than the law itself. (That’s why we get the big bucks — so you don’t have to read it!) Let’s take a quick look at some of the specific tax provisions:

• Extend Tax Cuts. The core of the bill, of course, extends the Bush tax cuts for two more years. This means the top rate stays at 35% (rather than 39.6%) and the rate on capital gains and qualified corporate dividends stays capped at 15% (rather than 20%). But the new law keeps taxes down for everyone, not just the highest earners. If those Bush cuts hadn’t been extended, the 10% rate would have disappeared, and tax brackets would have increased faster for everyone. So don’t think that you get no benefit just because you aren’t in those top brackets!
• Payroll Tax Relief. The bill reduces the employee portion of Social Security and self-employment taxes by 2% for 2011 only. This replaces the $400/person “Making Work Pay” credit in effect for 2010 — and ironically means higher taxes for individuals making under $20,000 and families making under $40,000.
• Estate Tax Relief. This is actually the most controversial part of the legislation. Under current law, the estate tax was scheduled to kick back in at 55%, on estates topping $1 million. Most observers expected Congress to restore the tax at the 2009 level, with a 45% tax applying on estates over $3.5 million. But the new law is even more generous, with a tax of just 35% on estates over $5.0 million. Again, this rule applies for 2 years.
• Other Provisions. Finally, the bill extends a laundry list of popular tax breaks that otherwise would have expired: (1) it “patches” the Alternative Minimum Tax system for two more years, thus protecting millions of Americans from the AMT, (2) it extends the Child Tax Credit and American Opportunity Tax Credit for college tuition, (3) it expands the Earned Income Tax credit for low-income working families, (4) it extends bonus depreciation and first-year expensing deductions for businesses, and (5) it extends miscellaneous tax deductions like educator expenses, state and local sales taxes, and tax-free IRA distributions given directly to charity.

Now let’s talk about what this all means. The reality is, the law’s provisions will last about as long as Grandma’s holiday fruitcake — two years at most. That means Washington will have to fight it out all over again — with a divided Congress, in a Presidential election year — with another $2 trillion or so added to the national debt on top of the $13.9 trillion or so that’s already there! Republicans naturally favor keeping taxes low to stimulate economic growth. And even Democrats, who would normally favor raising taxes to close the deficit, have been reluctant to do so in today’s weak economy. But if the economy continues to pick up over the next two years, there may be enormous pressure to increase taxes. This will make tax planning even more important over this period.

This holiday season, we wish you and your family all the best. Count on us to keep an eye out for the best ways to spread holiday tax relief. And remember to call us with your year-end finance questions!

When you think of Santa, you probably focus on what he gives. But have you ever thought about what he pays? You can be sure the grinches at the IRS do!

Santa is most famous for his holiday gift-giving. His “North Pole Foundation” is set up as a not-for-profit under Internal Revenue Code Section 501(c)(3). But Santa also operates a second, highly profitable business focused on licensing and endorsements. (In that sense, he’s like top athletes whose off-the-field income from endorsements far outstrips their on-field earnings.) So how can Santa shelter some of his own presents?

Fortunately, Santa can take advantage of many of the same deductions as any other business owner. Those include:

• Mileage. Santa can choose to deduct “actual expenses” (maintenance, upkeep and depreciation on the sleigh, reindeer chow, etc.) or the standard allowance (currently 51 cents per mile). In Santa’s case, the sheer length of his trip around the globe to deliver toys to all the good little girls and boys makes the allowance his best bet. (His sleigh also qualifies as “energy efficient” — it’s 100% “green,” running entirely on reindeer power, and even Rudolph’s nose is low-wattage.)
• Uniforms and work clothes. Clothing Santa provides for himself and his elves are deductible so long as they’re not “suitable for ordinary street wear.” This time of year it seems like everyone enjoys a red coat and hat. Still, we feel confident Santa’s classic look is distinctive enough to pass the IRS test.
• Home office. Home offices are deductible so long as they’re used “regularly and exclusively” for work and constitute the “principal place of business.” Santa’s North Pole workshop certainly qualifies, which means he can write off depreciation, utilities, cleaning and maintenance, and holiday decorations. Code Section 132(j)(4) even lets him write off “on-premises employee athletic facilities” for holding reindeer games.
• Retirement. Santa seems to love his job now. But how will he feel about his long night’s work as he ages? He’ll probably want to stuff some cheer in his own stocking. The problem is those naughty nondiscrimination rules that force him to contribute on behalf of his elves. We recommend a “safe harbor” 401(k) to maximize his own contributions without worrying that the plan become as “top-heavy” as his sleigh.
• Family employment. It’s not clear if Mrs. Claus holds a formal position in Santa’s organization. However, putting her “on the books” would let Santa boost the couple’s retirement plan contributions and maybe establish a Section 105 medical expense reimbursement plan to write off his cholesterol medication and other medical bills as business expenses.

This holiday season, we wish you and your family all the best. And remember — don’t hesitate to call us with any year-end finance questions!

Christopher Brown, CPA
Brown & Company, PLLC