Recovery Lags Other Recessions

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Jan. 27, 2012, 2:48 p.m. EST

Economic recovery is still threatened

Commentary: Tax cut, jobless benefits needed to support consumers

By Adam Hersh

WASHINGTON (MarketWatch) — The U.S. economy picked up speed in the last quarter of 2011, but it is still hung over from the 2000s’ real-estate-bubble-driven economy, according to data released today by the Bureau of Economic Analysis. With our economic recovery still facing numerous risks, policy makers should continue soon-to-expire payroll tax cuts and unemployment insurance benefits to sustain growth momentum.

In the final quarter of 2011, U.S. gross domestic product, or GDP — the measure of all goods and services produced by workers and property in the United States — expanded at 2.8% annualized rate and now stands $96 billion larger than before the start of the recession four years earlier.

This marks the 10th consecutive quarter of economic expansion and the best growth performance for the U.S. economy since the height of the Recovery Act in early 2010. Read MarketWatch’s full coverage: Economy expands 2.8% in fourth quarter.

But beneath the surface of today’s headline growth figure, middle-class and low-income families’ financial stress, residual real estate weakness, and government fiscal contraction are taking a toll. Our economic health is much more fragile than the fourth-quarter growth suggests, and what drove growth this quarter is unlikely to sustain moving forward.

U.S. GDP rises 2.8%

The U.S. economy grew at its fastest pace in more than a year and a half in the final three months of 2011, rising at an annual rate of 2.8%. Kathleen Madigan reports on the Markets Hub.

Consider that nearly two-thirds of the overall increase in GDP was driven by businesses restocking their inventories after depleting them earlier in the year. The next-largest contributor to growth in the fourth quarter came from households, who cut back on saving in order to spend more on consumer goods.

But with household indebtedness exceeding 114% of after-tax income, consumers will eventually be forced to boost saving and reduce consumption. Cutbacks on public investments and services are likely to further reduce demand at present and along with that the foundation of longer-term private sector growth.

There are also some bigger picture concerns. Comparing the experience of consumption and investment through the current business cycle with the experience on average in previous post-World War II recessions makes clear that the post-bubble debt-overhang we now face distinguishes this recovery from most others. (See the charts at the top of this article.)

It’s true that consumer spending by households, the single-largest component of the U.S. economy, increased at a 2% rate in the past quarter. It’s now up 1.5% over pre-recession levels. But compared to previous recessions, the recovery of household consumption looks markedly weak. At this point in past business cycles, consumption on average had increased nearly 14%.

And the slow growth of consumption actually understates the financial stress faced by households: Despite growing in aggregate, personal consumption is actually 1.4% lower on a per-capita basis than four years ago. Without critical social safety net programs, it would be even lower.

The persistently weak residential real estate market is further adding to the financial stress on families. Whereas in typical recessions residential investment tends to lead the recovery, up 23% on average at this point in the business cycle, at present it is languishing more than 45% below its pre-recession level. With home prices yet to stabilize in most regions, owners coping with overvalued mortgage payments, and one in eight mortgages in foreclosure or delinquency, resolving weakness and uncertainty in the real estate market are central to boosting both household consumption and residential investment.

The economy is clearly not working for all Americans, either, with 13 million unemployed workers and countless middle-class and low-income families struggling financially. The gap left in consumer demand by financially stressed families is restraining private business growth and investment, as well. For a time, the Recovery Act and related increased public investment, services, and tax cuts helped fill the hole in demand. But in each of the past four quarters government fiscal contraction slowed economic growth by more than half a percentage point on average.

Small-business owners surveyed by the National Federation of Independent Businesses reported “poor sales” (i.e., lack of demand) as their number one problem for the past 40 months. With uncertain prospects for expanding sales, business investment, too, is far behind the pace of previous economic recoveries. Investment in equipment and software grew incredibly through late 2009 and much of 2010 in concert with Recovery Act investments and tax incentives, but slowed to 5.2% growth at the end of 2011, primarily in information technologies. Four years later, equipment investment is 3% above its pre-recession level, but it’s more than 12% behind the pace of previous recoveries. Insufficient demand also constrains business investment in commercial real estate and factories, which is down 35% since the start of the recession.

In addition to weak demand that hampers growth, numerous risks on the world economic horizon — Europe’s simmering banking crisis, slowing growth in China, and potential oil price volatility — threaten to blow headwinds against the still-fragile growth in 2012.

But perhaps the biggest threat to growth remains the home-grown risk of self-inflicted damage from continued political intransigence in Congress. American businesses, and the middle-class consumers on which they rely, will take a big hit if Congress fails to continue unemployment insurance benefits and payroll tax cuts for all working Americans, both set to expire in February.

Keeping this money in the pockets of consumers will help families to continue meeting their needs and give certainty to businesses about where their next sale will come from so they will hire and invest more.

Adam S. Hersh is an economist at the Center for American Progress,

Independent Contractor or Employee? IRS and Dept of Labor to Share Data

Worker Classification Issues on Washington Agenda DC CURRENTS

by Benson S. Goldstein, J.D.

Published January 01, 2012

Worker classification issues have become a major tax administration focus in our nation’s capital over the past few months. First, on September 21, 2011, the IRS issued Announcement 2011-64 establishing a new voluntary classification settlement program (VCSP) “that provides partial relief from federal employment taxes for eligible taxpayers that agree to prospectively treat workers as employees.” Second, in the same month, the IRS and the Department of Labor (DOL) signed a memorandum of understanding (MOU) to share information regarding employee “misclassification.” And should those actions not prove sufficient, President Barack Obama included a worker classification provision in the September 2011 release of his plan “Living Within Our Means and Investing in the Future: The President’s Plan for Economic Growth and Deficit Reduction.”
Worker classification cases have been a significant bone of contention for the IRS for decades. Businesses that hire workers as independent contractors save money on federal employment taxes, and the independent contractors may view themselves as “entrepreneurial” small-business persons. Determining whether a worker should be treated as an employee or as an independent contractor depends upon a facts-and-circumstances test revolving around a common-law test of whether the service recipient has the right to direct and control how the worker performs the services provided.
IRS revenue agents often take the position that these workers are misclassified and that a business utilizing the skills of these workers owes a large federal employment tax bill. Sometimes the IRS wins such cases against business taxpayers based on the common law; under other circumstances, the Service finds itself stymied from pursuing a case due to Section 530 of the Revenue Act of 1978.
Robert W. Wood, a California attorney, calls Section 530 “a veritable get-out-of-jail-free card that forgives many instances of worker misclassification” (Wood, “Independent Contractor or Employee? The 100-Year War,” 132 Tax Notes 199 (July 11, 2011)). As long as a taxpayer has a reasonable basis for treating a worker as an independent contractor, Section 530 may permit the worker to be treated as a nonemployee.
Under the VCSP, taxpayers may voluntarily reclassify workers as employees for federal employment tax purposes and obtain relief similar to that offered under the current classification settlement program (CSP). To be eligible for the VCSP, the taxpayer must:

• Have consistently treated its workers in the past as nonemployees;
• Have filed all required Forms 1099 for the workers for the past three years; and
• Not currently be under audit by the IRS, the DOL, or a state agency concerning worker classification matters.

If an entity is interested in applying for the VCSP, the taxpayer should complete Form 8952, Application for Voluntary Classification Settlement Program, at least 60 days before it wants to start treating the workers as employees. Employers accepted into the VCSP will pay an amount effectively equal to 10% of the employment tax liability due on compensation paid to the reclassified workers for the past year. (For more information on the VCSP, see the IRS website.)
Under the September 19 MOU, the DOL’s Wage and Hour Division will share information or data with the IRS related to DOL investigations involving employment tax compliance. In return, the IRS will (1) evaluate and classify employment tax referrals provided by the DOL and conduct employment tax examinations if appropriate; (2) share (when consistent with applicable federal laws) the DOL’s employment tax referrals with state and municipal taxing agencies if approved information-sharing agreements are in place; and (3) share with the DOL annual reports and aggregate data relating to trends in misclassification in a manner that protects return information and taxpayer identities. Both agencies mutually agree to share training materials and participate in joint public outreach events. (For more on the MOU, see this month's Tax Clinic.)
President Obama’s jobs plan for economic growth and deficit reduction, mentioned above, includes a provision that would permit the IRS to (1) issue regulations or other guidance addressing the “proper” classification of workers and (2) require the prospective reclassification of workers who are currently considered misclassified and whose reclassification would otherwise be prohibited under Section 530. The plan would waive penalties for service recipients with a small number of employees and a small number of misclassified workers, if the service recipient has consistently filed all required information returns for its workers and has agreed to prospective reclassification of the workers to employee status.
The only certainty in all this is that the IRS will continue to offer its classification settlement program to businesses that it believes are misclassifying workers as independent contractors. With respect to congressional action on the president’s jobs plan or even a separate worker reclassification bill, the chances of passage during 2012 are unclear, given the upcoming national election and the fact that the Senate is controlled by the Democrats and the House of Representatives is in Republican hands.

EditorNotes

Benson Goldstein is senior technical manager (taxation) at the AICPA in Washington, DC, and is staff liaison to the AICPA’s IRS Practice and Procedures Committee. For more information about this column, contact Mr. Goldstein at bgoldstein@aicpa.org.

Handling IRS Requests of Quickbook Data Files

Handling IRS requests for accounting software backup data
Internal Revenue Service agents have begun requesting backup files from taxpayers' accounting software during examinations. Practitioners need to understand the scope of the IRS's authority to make these requests and how to help clients provide the necessary data, but not more information than is required. Journal of Accountancy (1/2012)     

Quote For the Day

"We can't solve problems by using the same kind of thinking we used when we created them."

--Albert Einstein, German-born physicist

Are Unemployment Benefits Taxable?

All 2011 unemployment insurance benefits taxable

January 23, 2012|Carole Feldman, Associated Press

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The jobless rate is dipping, but millions of people are still out of work. And that could have implications when they file their income tax returns.
Collecting unemployment insurance benefits? All that you received in 2011 is taxed as income. Unless you requested that federal taxes be withheld, you could be in for a big surprise when you calculate taxes owed.

If it’s any consolation, you may find yourself in a lower tax bracket because of reduced income, even counting the unemployment benefits. And you might also be eligible for tax breaks that you didn’t qualify for before.  “If you have major household changes, say you lost your job in 2011, we encourage people to take a close look at things like the earned income credit,’’ Internal Revenue Service spokesman Terry Lemons said.  He said people should go ahead and file their taxes even if they don’t have the money to pay any taxes that are due. “There are more options there than many people realize,’’ he said, including installment agreements.
The aftermath of the Great Recession, which gripped the nation from 2007 to 2009, is still being felt across America. Employers still worried about the state of the economy are hesitant to bring on new workers. And many of the more than 13 million unemployed people have stopped looking for jobs.
For those who spent part or all of 2011 searching for work, there are tax breaks.  “All of those job search expenses are deductible — the stationery, the long-distance phone calls, the hotels, anything you can relate to the job search,’’ said Jeff Schnepper, author of “How to Pay Zero Taxes’’ (McGraw-Hill, 2011).  To qualify for this deduction, you have to be looking for a job in the same field or profession as your previous one. Expenses incurred trying to get your first job are not deductible. “Until you start working, you don’t have a profession,’’ Schnepper said.
You also have to itemize. And the cost of preparing your resume, working with job search services, mileage and other job search expenses has to exceed 2 percent of your adjusted gross income if you are to benefit, according to Greg Rosica, tax partner with Ernst & Young.  Make sure you save your receipts. “You have to be able to substantiate,’’ he said.  Those out of work may find the jobs have dried up in their cities or towns. “Many people are picking up and moving to where the jobs are,’’ Meighan said.

Taxability of Damages for Personal Injury or Sickness

IRS issues final regulations on damages received for personal injury or sickness
The Internal Revenue Service on Friday issued final regulations removing the requirement that damages received from a legal suit, action or settlement for personal physical injury or sickness must be based on “tort or tort type rights” in order for the taxpayer to exclude them from income. They also clarify the excludability of damages for emotional distress. The final regulations adopt rules that were proposed in 2009, and they apply to damages received after Aug. 20, 1996. JournalofAccountancy.com (1/20)     

Federal Tax Information Aplenty through Social Media

 IRS2Go The IRS recently launched a smartphone application that allows you interact with the IRS using your mobile device. Our app can help you get your refund status and tax updates. IRS2Go is available for the iPhone or iTouch and the Android.

Reporting Investment Gains Incurred in 2011

Investors Prepare for problems with Cost Basis Reporting on 2011 Returns.

A provision in the  Emergency Economic Stabilization Act of 2008 requires brokers to report to the IRS the amount you paid for that stock — that is, your cost basis. The purpose of the new law is to make sure investors don’t pay less than the law requires in capital-gains taxes.

For your 2011 tax return, the law applies only to stock transactions. Beginning in 2012 the rules will apply to mutual funds and exchange-traded funds, and then in 2013 to fixed-income and commodities investments.

By Feb. 15  of next year, brokers must mail to investors  and  the IRS cost-basis information on the revised Form 1099-B. Investors will use that information to fill out the new Form 8949, which is then used to complete the revised Schedule D.

How to Report

Investors always had to report cost-basis, of course. So, eventually, the fact that brokers are providing that information likely will make their tax-filing lives easier. But the first few years of the new rules will create a good deal of confusion, given that only certain transactions are “covered” and required to be reported by the broker — while other transactions are not covered but will still have to be reported to the IRS by the taxpayer.

If in 2011 you bought stock through the same broker where you ended up selling the shares, that’s a covered transaction. All of your other sales transactions, including those involving stock you bought before 2011 are not covered.

That means when filling out the 2012 Form 8949 taxpayers could end up filing as many as six pieces of paper because they must file a separate page of the form for each of the following situations: short-term gains or losses (the security was held for one year or less) that the broker is reporting to the IRS; short-term transactions that are not being reported by the broker; long-term sales that the broker is reporting; long-term sales the broker is not reporting; and short- and long-term sales that don’t fall into either of those two previous categories. You can find Form 8949 and Schedule D instructions on this IRS.gov page.

Stock Options

In stock-option transactions, the Form 1099-B you receive from the broker may underreport your cost basis, causing you to overpay taxes unless you adjust the amount. That can happen because the broker may not include the compensation component of the transaction which increases basis which can serve to lower your gain (or increase your loss). In that situation, you may also need to make an adjustment on Form 8949.

Reporting of investment gains and losses is going to become much more difficult beginning with the filing of 2011 tax returns and if you have not previously engaged the services of a CPA, next year may be the time to do so.

Harvard Alums Project Economic Decline

Harvard alums say tax code, politics drive U.S. decline
Harvard Business School alumni are pessimistic about the U.S. economy, with 71% expecting a decline in competitiveness over the next three years, according to a survey of 10,000 former students. The political system and its broken tax code were the top reasons cited. The Hill (1/18)     

Accelerate Income into 2012 - Tax Rate Increases Likely for 2013

Expert: Taxpayers should accelerate their income in 2012
Clients may want to accelerate income in 2012 in case tax rates begin to climb next year, says Deb Wetherby, principal of Wetherby Asset Management. "For a long time rates were falling so it was all about deferring income," she said. Wetherby suggests selling assets and recording capital gains before the end of 2012, or deferring property-tax payments or donations in order to gain a deduction in 2013. Financial-Planning.com (1/12)     

Obama's Proposed 2013 Budget Contains Tax Increases

Obama to reintroduce taxes, deficit cuts for 2013 budget
In his fiscal 2013 budget, to be presented to Congress in early February, President Barack Obama reportedly will revive tax increases for wealthy Americans and deficit-reduction strategies that he proposed last year. In addition to the previously rejected ideas, Obama will propose new incentives for companies who bring jobs back to the U.S. Bloomberg Businessweek (1/12)     

Increase in High Income IRS Audits

Advisers warn high-income clients of IRS audit risk
Advisers are telling their high-net-worth clients to be more cautious in case of an audit by the Internal Revenue Service. Some suggest that clients improve record-keeping and hire appraisers to value assets. Recent data show that the IRS is increasingly focusing audits on people with income of $1 million or more. Financial-Planning.com (1/13)