In The Black

Steve Metzenthin, CPA, CFP, CVA

The Congressional Budget Office recently issued the government’s latest revenue and spending figures for the fiscal year ended September 30, 2011. They are summarized below in billions of dollars:

Year                Receipts        Outlays          Deficit

2008              $2,524          $2,983          $    459

2009              $2,104          $3,520          $1,416

2010              $2,162          $3,456          $1,294

2011              $2,303          $3,600          $1,298

Taxpayers are regularly reminded that the U.S. government is not like private enterprise, since the government can create its own financing.

I was curious to see, however, what would happen to the balance sheet of a private corporation if its managers generated the same results as the government did for the above period.  The results are horrifying.

I created a balance sheet as of September 30, 2008 under the following assumptions: (a) current assets were fixed at 120 days of fiscal year 2008 revenues; this consisted of cash and inventories at 30 days each and accounts receivable at 60 days; (b) fixed assets were $500,000; (c) the debt to equity ratio was set at a conservative 1:3 ratio in order for the starting balance sheet to be healthy.  My private company generated revenues in 2008 of $2,524,000 and reflected the same annual revenues and expenses as the government, except that the above amounts were in thousands, not billions.

At September 30, 2008, the balance sheet looked like this:

This is the balance sheet of a nice little company – well capitalized, acceptable balance sheet ratios and equity book value in excess of a million dollars.

The next step was to roll the losses through the three fiscal years ending in 2009-2011 in order to generate a September 30, 2011 balance sheet. To do this I assumed: (a) all asset balances remained constant; and (b) that losses were financed entirely by debt.  This is the resulting balance sheet:

This is the balance sheet of a disaster. The company is well beyond bankrupt and it would be impossible to overstate the fiscal incompetence which led it to this point.  What do you suspect are the odds of the lender being able to get his $4,342,333 back from the borrower?

So I guess the moral of the story is that we had better hope that government is different!!

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Steve Metzenthin, CPA, CFP, CFE, CVA

Congress has reconvened.  The lame-duck assembly now in session is controlled by Democrats, but this will change in January.  The current session promises to be one of the most entertaining, if not necessarily one of the most productive sessions in recent history.  In the next few weeks which include Thanksgiving and Christmas recesses, there are three separate groups of tax issues to be addressed: estate and gift taxes, income taxes, and extenders.  I will address them in separate posts.  Today we’ll tackle estate taxes.

Since my earlier post (Estate Tax in the Horse Latitudes) not much has happened.  As a result, here we are on November 23, 2010, and estates of those dying in 2010 are still in limbo.  For an abstract of a piece written in October by Donald Marron for the New York Times Freakonomics blog click here.  I agree with everything he says and believe his views pretty much sum up the views of most practitioners.

As things stand now for 2010 there is (a) no estate tax for deaths in 2010.  The IRS has indicated that they will not accept estate tax returns; (b) no asset step up.  Assets transferred at death will obtain a “modified carryover basis” which is essentially the cost basis to the decedent plus upward adjustments of up to $3 million for transfers to surviving spouse and $1.3 to others; (c) lifetime gift allowance of $1 million, not including annual exclusion present interest gifts currently $13,000 per donee per year, then taxed at 35%; and (d) no generation skipping tax.

As things stand now for 2011 (a) estates over $1 million will be taxed at rates that go as high as 55%; (b) assets will be stepped up to their fair market value at date of death; (c) lifetime gift allowance of $1 million, not including annual exclusion present interest gifts currently $13,000 per donee per year, then taxed at 45%; and (d) generation skipping tax returns with a maximum rate of 55% and $1 million exemption.

To repeat a point made earlier and by many: this is obscene.  A billionaire’s heirs are free from estate tax in 2010, but the estate of a person with $250,000 in home equity, $250,000 in savings, and $500,000 in an IRA is subject to the estate tax if the death is in 2011.  We might argue about many things, but it is unlikely that many are in favor of estate taxes being levied on the estates of those whose assets were insufficient to provide for the decedent while he or she was alive.  But that is the reality of our current tax regime and investment markets, most notably interest rates.

Several things can happen from here.  If the lame duck session gets feisty, it could pass a law which would retroactively reinstate the estate tax for 2010 deaths.  There are both political and constitutional issues that make this problematic, but it could happen.  However, the odds are against this, and in any event are much lower than before the elections.

A few experts have indicated the possibility of lame duck legislation retroactive to the beginning of 2010 that would give to executors the option of either paying no estate tax or not obtaining a basis step up.  This probably doesn’t do a whole lot (at least in the case of large estates) since few executors would pay large amounts of current estate tax to avoid higher future income taxes on sales of assets transferred to the beneficiaries by the estates, but it would provide some political cover.  There is no possibility of retroactive reinstate of the estate tax to 2010 by the new Congress if the lame duck group fails to do so.

Once the new Congress is seated, it’s hard to tell what will happen going forward.  For some time those of us who work in the area believed that the grand compromise would include a lifetime allowance of $3.5 – $5.0 million per person with a top rate around 45%.  This was rejected for political reasons by both parties when they were in power, so it’s hard to say for sure that it won’t be rejected again.  It shouldn’t, but it could.  Stay tuned.

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Steve Metzenthin, CPA, CFP, CFE, CVA

Former secretary of the U.S. Treasury Robert Rubin has co-authored a piece in today’s Wall Street Journal in which he urges Congress to enact legislation which would permanently tax estates over $3.5 million at a top rate of 45%.

Something clearly needs to be done.  The law currently is so convoluted that it makes sense to nobody – if a billionaire dies during calendar year 2010, no estate tax is due, but if an individual with an estate of more than $1.0 million dies in 2011, an estate tax of up to 55% is due on the extra amount.  At today’s low interest rates, it is conceivable that a person who does not earn enough interest to comfortably support his or her lifestyle while alive would nevertheless leave a taxable estate to his heirs. Incredible.

Our leaders in Washington get to take full credit for this.  The whole issue of estate (“death” if you are a Republican) taxes has been a political football for years.  Though Rubin can be applauded for a suggestion that will at least clear up the mess (the exemption amount and the top rate suggested more or less fall in line with what estate tax planners and practitioners have been thinking would eventually come out of all this)  the reasoning behind his suggestions will cause teeth to gnash.

Perhaps unintentionally, perhaps not, his arguments are partisan and political in nature. They start with the idea that public investment (i.e. government spending) is more efficient than private sector savings and debt repayments, and that maintaining our view of ourselves as a meritocracy and land of opportunity is enhanced by having the government collect and spend tax dollars in order to avoid the private accumulation of  excessive economic and political power.  Is there anything that we are arguing about more these days? Try convincing someone with even a smidgen of traditional liberal belief that somehow it is more meritorious for the government to accumulate (and spend) privately owned and previously taxed wealth, than it is for private citizens to keep it themselves.  You won’t win that argument.

The argument for retroactivity – that it is justified because public officials have been talking about it and that no one died earlier as a result – is flat bizarre.  Public officials talk all the time about things best ignored and I’m thinking that the timing of death under the circumstances could depend on the answers to two questions: how rich and how sick?

So here’s the argument I would make instead.  We need to clear up the mess.  The uncertainty associated with estate and gift taxes is yet another in the quiver full of uncertainty arrows that continues as a drag on economic recovery and mounting fiscal problems.  We have a responsibility to the public to be clear and transparent.  An exemption of $3.5 million and a top tax rate of 45% represent a compromise between those who believe that taxing estates is immoral and those “progressive” thinkers who would tax at a much higher rate in the interest of redistributing wealth.  Maybe the numbers should be $5.0 million and 35%, but no matter. Get it done.

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Steve Metzenthin CPA, CFP, CFE, CVA

The Business Rountable (BRT) is an influential trade association whose members collectively represent many of America’s largest and most influential business corporations.  Until recently, members of the association and the BRT itself have generally made attempts to get along with the Obama administration and have supported its financial and economic initiatives – to the extent that some have criticized the support as constituting initial steps toward rent seeking.

Therefore when the BRT’s Chairman Ivan Seidenburg, whose day job is as the Chairman and CEO of Verizon Communications, delivered a speech to the Economic Club of Washington on June 22, 2010, containing a number of criticisms of the Administration’s policies, it became big news.  The BRT also delivered to the White House a 54 page critique based on a survey of its membership. This post will summarize and outline the key components of the speech and the report.

• Injection of Uncertainty into Marketplace – the BRT cites what it describes as a “disconnect” between Washington and the business community that is harming business’s ability to expand the economy.  By reaching into essentially all sectors of economic life, government is injecting uncertainty into the marketplace and making it difficult to raise capital and create new businesses.  This is evidenced by the stubbornly high unemployment rate.

• Main areas of inputs – The BRT believes that five areas in particular need to be addressed in order to create growth and private sector jobs – capital formation, exports, infrastructure, education, and innovation – and urges that “micromanaging” of industries has a counterproductive effect.

• Policy Burdens Inhibiting Economic Growth and the Cumulative Effect of Regulations and Legislation – Business are acting cautiously to forestall negative impacts resulting from massive new laws, particularly those covering health care and financial reforms.  This results in companies freezing investments and hiring.

• Taxes – BRT was particularly critical of the high level of corporate tax rates and what it described as proposed sweeping changes to U.S. tax law that would make U.S. companies less competitive in foreign markets. 

• Financial Regulatory Reform – BRT criticized provisions in proposed legislation that would create a new federal right for shareholders to nominate directors, stating that it would reduce efficiency, stifle completion, and deter capital formation.  In addition, new margin requirements on accounts set up to execute transactions in the over the counter derivatives market would increase the effective cost to certain businesses of “hedging” price changes and would have the overall effect of reducing capital spending.

• Trade – BRT was critical of the Administration’s failure to move forward on pending free trade agreements, particularly with Colombia, Panama, and South Korea.

• Labor – BRT members are concerned over support of the Employee Free Choice Act (so called Card Check bill) which would eliminate secret ballots in union organizing elections and would empower the government to intervene in labor disputes through compulsory arbitration.  The association also was critical over a provision being considered by the Vice-President’s Middle Class Task Force would award federal contracts to companies providing such things as living wage, health care, retirement and paid sick leave, and taking neutral positions in union organizing campaigns.  The membership expressed its concern that by awarding on the basis of such factors, the provisions will increase the cost of contracts to the American taxpayers.

• Energy and Environment – BRT is critical over the EPA’s recent policy proposals that will permit it to regulate greenhouse gas emissions under the Clean Air Act; and it criticized the recent sweeping restrictions on drilling in response to the Deepwater Horizon tragedy.

• Health Care – The recently passed health care legislation gives significant jurisdiction to those writing regulations to clarify and interpret the law.  BRT states that successful implementing the rules “may require even more vigilance that the drafting and passage of the reform law itself.”  The report is also critical of the law itself, stating that it does little to change underlying problems of the delivery system of providing health care.  This will result in ongoing cost increases continuing to shift to the private market.

• Net Neutrality – The Federal Communications Commission has proposed regulations that would place significant restrictions on network management practices which would hamper the ability of networks to handle Internet traffic.

• Home Affordable Modification Program – The HAMP program has been a dismal failure and should be discontinued.  Mortgage industry intermediaries best serve an economic recovery by quickly moving their real estate owned properties into the market place.  The HAMP program retards this process.

• Reduction in Government Debt – Current levels of U.S. debt will crowd out private capital.  This will “retard future growth and investment, erode the value of the U.S. dollar, accelerate inflation, and, eventually, reduce consumer spending.”  To best get the full flavor of the comments related to this topic, I will quote at length:

“We are extremely concerned about the government’s recent rate of growth, the impact it will have on the country’s status as an investment safe-haven and the cascading effects on private investment.

“As the government’s debt increases, a greater and greater portion of government spending will be needed to service that debt, in turn crowding out private capital.  Increased debt also brings an increased risk of having that debt downgraded.  Because the United States Treasury’s lending rates are considered “risk-free” they serve as the floor for corporate borrowing rates: if Treasury’s lending rates go up, everyone’s lending rates go up.  We believe that unless the government takes action to manage its spending the consequences will include:

• Less capital available for corporate borrowers, which will retard future growth and investment.
• Rising interest rates for all borrowers.
• Potential loss of the United States’ “safe-haven” status.
• Erosion of the value of the U.S. dollar.
• Potential for accelerating inflation and the resulting loss of consumer spending power.”

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