a normal start to the new year

a down day

Stocks sold of throughout the day yesterday.  Nothing unusual about that, especially after the strong performance of stocks on Wall Street last year.

My take is that this is taxable investors, predominantly individuals and not mutual funds or other taxable institutions, I think, who are rearranging the positions where they have gains.

what to do

Three things, other than rearranging your own holdings:

1  wait for the selling to abate  The amount of downward pressure on the market and the number of days it takes for selling to tail off will tell us a lot about the overall tone of the market.  Shallow and short are my guesses–but I’m content just to watch to see how tax-selling plays out.  It’s always possible that selling will begin to feed on itself and turn into a minor correction.  I don’t think so, but I find the twists and turns of the market nearly impossible to predict.  So my primary inclination is to watch and wait.

2.  analyze  Look for odd price action–either stocks that come under a lot of pressure or ones that are rising in a down environment.  Yesterday, the strength of TWTR really caught my eye, as did the up movement of SPLK, WYNN and LVS.  That’s bullish for all four (all of which my family owns).  I’m not looking to buy any of them right now, but if I were I’d be thinking I shouldn’t wait for them to dip before buying at least part of the position I was contemplating.  I know that’s not watching and waiting, but…

3.  shop for bargains  For example, I’m intending to add to my VZ before the merger with VOD happens.  So a several-day selloff in the former would suit me fine.  I’ve got one or two stocks earmarked for sale at slightly higher prices.  But if I could find a replacement at, say, 5% less than I’d expected to pay, I’d make the switch now.

Also, for anyone in the northeast US, try to stay warm.  It’s -9 degrees Celsius in New York now (colder in the suburbs).  It will be -15 tonight.  The wind is making it feel 5 to 8 degrees colder.  Brr!

dissecting the fiscal cliff

I’m back home, in the land of electric power and heat, but no internet or TV.  I’m using my phone as a mobile hot spot, but I can’t seem to get a look at the layout of this page.  Sory if the numbers below are hard to see.

Hurricane Sandy humor:

–a runaway Coca-Cola truck knocked down a utility pole on our street on Saturday, splaying live wires all over the place.  Luckily it wasn’t the more important one the big tree knocked down during the storm.  PSEG cleaned up in a matter of hours.

–I called/chatted with Comcast to find out about restoration of internet/TV service.  The two people I spoke with were very nice but said they had no idea.  Both confirmed that Comcast continues to charge customers for service even though there is none.  You have to call them and ask for a refund!!!  Why am I not surprised?

Today’s post:

“Economic Effects of Policies Contributing to Fiscal Tightening in 2013”

On November 8th, the Congressional Budget Office issued an update on its fiscal cliff analysis, titled “Economic Effects…”.  The report makes several points:

1.  “driving over” the fiscal cliff isn’t a good idea

The problem is the domestic economy is still very weak.

The CBO predicts that continuing Washington stalemate would cause a short but sharp recession in the US during the first half of next year.  Growth would resume from the crunch, but from a lower level, in the second half.  But this would be by a small enough amount that real GDP would still end up in the negative column for the full year.

More important, unemployment would spike upward to an estimated 9.1% a year from now, postponing the return to economic normality for the country (meaning reduction in the unemployment rate to 5.5%) until early in the next decade.

2.  the status quo isn’t so hot, either

Continuing the current situation where Washington continually spends more than it takes in will ultimately force interest rates in the US–both for the government and for private borrowers–higher than they would otherwise be.  Maybe a lot higher.  At some point we’ll have a repeat of 1987, when domestic lenders refused to buy any more government debt and the long bond spiked to 10%.  The CBO implies that this is only a remote possibility at present.  But as the debt grows the problem becomes progressively harder to solve.

3.  the long-term solution

(I haven’t seen anyone write about this.)  For the CBO, two moves are important.

–broaden the tax base, don’t raise rates.

–reduce entitlement spending.

4.  in the short term, however…

(short = the next two years)

…postpone part or all of the fiscal cliff elements.  Address the deficit issues in an aggressive way in 2015, when the economy will presumably be healthier and unemployment lower. That way, we have a much better chance to get chronic unemployment under control.  If so, we’re likely to reach full employment in 2018–a time when we can attack the government fiscal mess in a more serious way.

5.  components of the cliff

The numbers are the boosts to real GDP that each would likely provide:

extend expiring income tax provisions for everyone          +1.4%

do so, but omit high-income earners                        +1.3%

extend payroll tax reduction, emergency unemployment benefits             +.7%

eliminate defense spending cuts               +.4%

eliminate non-defense spending cuts          +.4%.

my take

–The CBO analysis doesn’t take anticipatory effects into account.  In other words, it doesn’t address the issue of whether the slowdown in growth we’re now seeing in the US is adjustment in advance to the worst-case (“driving over”) scenario.  If so, the positive economic effects of breaking the logjam in Washington could be greater than the CBO estimates.

We can certainly see effects in the number of M&A deals being done before yearend—DIS/Lucasfilms is a good example.  But there are lots of others.

–Whether income tax rates rise for high-income filers has very little economic significance.  +/- 0.1% in GDP growth amounts to a rounding error.

–From a stock market perspective, the Obama-proposed increase in the tax on dividends is the key possible change that I see.

–Generally, I’m skeptical about arguments that depend on “fairness,” because I think the concept is so perspectival.  In a lot of cases, “fair” equates to just “I get more and you get less.”  Having said that, I think one of the most un-fair things in the tax code is Romney-esque carried interest, whereby high net-worth financiers turn ordinary income into capital gains.  I wonder if that loophole will be closed.

 

 

states casting about for new revenue sources

States in the US are trying to repair tattered balance sheets.  In addition to laying off workers and trying to reduce compensation to remaining employees, they are also working hard to develop new revenue sources.  Here are two of the most recent developments:

1. California just passed a law taxing sales over the internet.  It applies to purchases made by California residents from online companies that have a presence in the state.  You’d think that “presence” means factories, warehouses, sales offices, or bricks-and-mortar retail outlets–and it does.  But the new law also says that if a shopping comparison or coupon site located in California refers a customer to an online retailer, and the customer buys something, the fact that the comparison site is in California counts as a presence of the online retailer in the state.

According to the Los Angeles Times, Sacramento figured this new wrinkle to the sales tax would raise $317 million a year in new revenue.  What could they have been thinking?

What’s happened instead is that online retailers from Amazon and Blue Nile to Overstock and Zappos (yes, it’s cheating.  Zappos is part of Amazon, but I needed another end-of-the-alphabet site) have severed relations with the 25,000 or so comparison sites (oh, those wildly entrepreneurial Californians!) the Golden Sate has spawned.  Amazon has apparently sent its (former) affiliates a letter advising them to move out of state if they want to reestablish themselves with the online superstore.

According to the Financial Times, some couponing sites have lost up to 30% of their business since the new law went into effect.  More specialized sites appear to have seen the majority of their revenues evaporate.

Let’s assume that the 25,000 referral sites average four employees each (I’m making these number up, just to try to get a sense of the impact of the new tax).  That’s 100,000 jobs.  If half of the industry either relocates to other states or goes out of business, the new tax will have quickly generated a loss of 50,000 positions.  If each worker had been paying $5,000 yearly to California in sales, income property and other taxes, then the legislation would cause an annual loss of $250 million in state and local revenue.  And that’s without calculating unemployment benefits for laid-off workers.

…not exactly what the doctor ordered.

By the way, Amazon is urging a referendum on the tax, according to the FT.

2.  New York is redefining–“clarifying” might be the word the state would use–what it means to be a resident of the state for income tax purposes.  Details of two recent court cases that bear on this issue, the Barkers and John Gaied, can be found at taxdood.com.

Resident vs. non-resident–what’s the tax difference?  Non-residents pay income tax on income earned in New York;  residents pay income tax on all their income, including investment income.

The Barkers live in Connecticut, Mr. Gaied in New Jersey.  That’s where they vote, where they have their driver licenses, where their cars are registered, where they serve on juries, where their mail gets delivered (Mr. Gaied has some delivered to Staten Island, as well), where their kids go to school.

But,

1.  Mr. Barker works in Manhattan as an investment manager ; Mr. Gaied operates a gas station on Staten Island. Because of their work, both spend more than 183 days a year in New York State.

2. The Barkers own a vacation home on Long Island that Mrs. Barker’s parents use and they visit rarely;  Mr. Gaied owns a house on Staten Island that he bought for his parents to live in.

That’s enough to make them both residents of New York for tax purposes.  The facts that neither party spends much time at their New York houses, and that their primary residences are elsewhere, make no difference.  Owning and maintaining a residential property in New York State that looks like it could be lived in year-round is the essential thing.

Of course, the Barkers are also residents of Connecticut for tax purposes–so they’re taxed twice;  Mr. Gaied is similarly a resident of New Jersey.

According to the tax authorities, the Barkers owe an extra $608,000 in taxes to NYS for the years 2002-04.  After penalties and interest, the total bill is $1.055 million (an aside:  the tax bill implies the Barkers had over $6 million in investment income during the three years.  Wow!).

In the Gaied case, taxdood.com says the courts initially ruled in favor of Mr. Gaied, but political armtwisting got the matter reheard.  In round two, Mr. Gaied lost.

I think this effort by New York State bears watching.  My guess is that NYS is starting small, and will be aiming for bigger fish as the file of precedents gets bigger.  The tax authorities may end up raking in a pile of money.

It would be interesting to know what percentage of house/apartment owners in the Hamptons, or the Adirondacks, or the Catskills or the five boroughs of NYC are out-of-staters.  If it’s over 10%, these tax rulings can’t be good either for the construction industry in these areas, or for property values.

It seems to me that anyone who might be affected should either turn the property into rental real estate–so the property can’t be construed as a residence–or sell, in order to stop from running up additional tax liabilities.  And the news is certain to make vacation home seekers think more fondly of the Jersey shore or eastern Pennsylvania.

Stay tuned.


 

IRS: new rules for corporate tax reporting

setting the stage–or maybe just stuff I thought was interesting

According to the Bureau of Economic Analysis in the Commerce Department, the federal government collected $1.14 trillion in income tax from individuals and $231 billion from corporations last year.  That compares with recent highs of $1.5 trillion for individuals (2006–although the highs continue pretty much through 4Q08) and $454 billion from corporations (2005).

(As a matter of general economic interest, though not important for what follows, the BEA data show that the low point for corporate income tax receipts was the fourth quarter of 2008, when taxes were being collected at a $192 billion annual rate.  That compares with inflow at a $417 billion rate for 2Q10.  For individuals, the change has been less dramatic.  The low point was 2Q09 at $1,112 billion.  Currently the annual rate is $1,136 billion.)

the new rules for corporates

Unlike individuals, corporations have to let the IRS know when they think they’re doing something on their tax returns that may not sit well with the agency.  The “something” can be any of a multitude of potential sins.  To mention just a few possibilities, it could involve transfer pricing (improperly recognizing profit in a low tax rate country rather than in the US), expensing items that should be capitalized, recording sales as capital gains other than ordinary income.

The oddity about today’s rules is that the corporation has to tell the IRS that there are items they’re not highly confident would be approved of if audited, and the dollar amount involved, but not what the items are.

According to a recent article in the New York Times about this topic,  IRS agents assigned to looking at corporate returns can spend a quarter of their time trying to locate–presumably without much success–these questionable items.  So the IRS is changing the rules.  From now on, corporates will have to file a special form, Form UTP (uncertain tax positions) that will provide the IRS with a list of the items where they may have underreported income or overstated expenses.

what’s at stake?

According to the Times, publicly traded companies in the US paid $138 billion in income tax last year (the BEA number cited above includes all corporations, including ones not publicly traded).  Those firms also reported questionable tax positions amounting to about 150% of what they paid.

We won’t really know how solid a number that is until reporting under the new rules commences.  At present, it seems to me there’s no penalty for classifying tax treatment of a particular item as questionable, since the IRS isn’t going to find it anyway.  If it’s your bad luck that the IRS does happen to stumble on your uncertain item, at least you have some private record of your honest intentions to help deflect possible accusations of tax fraud.  Now the game has changed.  By listing an item on Form UTP you call attention to it.  But if you don’t, your protestations of good intentions are going to ring hollow.  If I had to guess, mine would be that the UTP number will shrink, but not by much.

who are the biggest UTP players?

The Times points us to The Ferraro Law Firm,  a Washington, DC-based company whose specialty is representing whistleblowers who report cases of corporate tax evasion to the IRS in return for a percentage of taxes recovered.  FLF has created the Ferraro 500, a listing of the US publicly traded companies with the largest UTPs.   Until we see reporting under the new rules, we won’t know whether the firms high up on the list have the most aggressive accountants or the most conservative ones, though.

The Ferraro 500 is constructed by taking the Fortune 500, a ranking of the largest US corporations by sales, and reordering them according to who has the largest absolute amount of UTPs.  The list isn’t perfect.  For one thing, 21 members of the Fortune 500 don’t disclose UTPs.  Also, some firms end up lessening the UTP number by allocating a portion to SG&A; some don’t (see the footnote at the very end of the Ferraro 500 list).

Then, there’s the question of what metric to use in analyzing the data.  I decided, at least partly because it’s simple to do, to look at the spread between a company’s ranking in the Fortune 500 and in the Ferraro 500.  Possible firms with very aggressive tax accounting would rank low on the Fortune 500 but high on the Ferraro 500.  “Good” firms would be the opposite.

There are 20 corporations in the Fortune 500 that have no reported UTPs.  The full list is at the tail end of the Ferraro 500, but they tend to be insurance companies or firms like Southwest Airways and the Washington Post.

Generally speaking, the companies with the smallest reported UTPs relative to their size are in the consumer discretionary and staples sectors.  The ones with comparatively large amounts of UTPs tend to be public utilities, particularly energy transmission and distribution, or financial companies ex the large commercial banks.

The companies with the greatest spread between their Fortune and Ferraro rankings, meaning small sales but large UTPs, sorted by the Ferraro ranking, are:

Starwood Hotels     Ferraro  41, Fortune 438

Agilent     43, 461

Amerigroup     47, 404

Avis     69, 409

Western Union     83, 413

Broadcom     100, 460

Century Telecom     114, 423

CA     115, 482

Applied Materials     116, 421

NCR     128, 451

Blackrock     130, 441

Electronic Arts     134, 494

ElPaso     144, 447.

A significant number of the members of this list, all of whom rank 300 places or more lower on Fortune’s compilation than on the large UTP one, are technology firms.  Yahoo was very close to inclusion, as well.  I’m not sure it’s right to make industry conclusions from this sample, however, since technology firms also feature prominently among those with relatively low UTPs.

My guess is that the stock market won’t pay any near-term attention to this change in IRS rules.  I think it’s something to keep a close eye on, however. Not only could some firms have a step change down in reported earnings next year as they reassess their tax strategies, but since the IRS has three years from filing date to initiate an audit, the IRS may well use Form UTP as a roadmap for examining prior year filings as well.