IRS vs Small Fry, Part 2

More on the IRS focusing its audit efforts on small taxpayers from CFO.com. In a recent post, we speculated on some conditions under which this might make sense. However, the study reported on and the experts interviewed in the article cast a far more shadowy light on the situation. For example:

• Audits of large companies have fallen dramatically over the past two decades, from 67% to 25%, despite offering the greatest potential dollar return per hour of agent labor.
• A “perverse quota system” might be incentivizing tax agents to pursue smaller companies, according to the authors of the study.

The IRS has indirectly defended its actions by reporting that it has increased its focus on pass through entities like S-corporations and partnerships, and by blaming “flat budgets.”

Tax experts quoted in the article point out that smaller companies are the locus of the “tax gap” problem — the difference between what is estimated to be owed in taxes and what is actually paid.

One of them also raised an interesting possibility regarding “sustension rates” (emphasis added):

While [Dean Zerbe, national managing director of tax consultancy Alliantgroup] says it is “difficult” to speculate on the decline in large-company audits, he points out that sustention rates (the ratio of agreed-on and upheld tax deficiencies to proposed tax deficiencies) may have something to do with the shift. Historically, sustention rates pertaining to large companies have been very low, says Zerbe. While the IRS may seek a high dollar amount based on underreported taxes, “the number drops like a stone” when the case gets to court and wends its way through the appeals process, he says.

Smaller companies also see the amount of tax they owe reduced in court, but “not nearly as dramatically,” notes Zerbe. That’s because they may not have the resources to challenge the IRS and are therefore more likely to settle. As a result, the IRS may see a better “bang for the buck” pursuing smaller companies, says Zerbe.

But targeting smaller companies may be bad for the economy on the whole, since audits consume the time and attention of business owners, adds Zerbe. ”While politicians in Washington love to give speeches touting how small businesses are the engines for job growth, revving up IRS audits of small business is like putting sugar in the gas tank,” he says.

We noted a similar irony while addressing healthcare reform back in March:

…employees of large corporations, unions, and public sector employees…have been subsidized, either through higher premiums, greater personal risk, or less health care, by the self-employed and entrepreneurs (which may be why politicians always try to kiss their rear ends)…

Our advice? Pay your taxes, small fry, but be wary of politicians kissing your keester. That smacking sound could signify an impending audit. 

URLs:

http://www.cfo.com/article.cfm/14493089

http://654advisors.com/index.php/blog/2010/04/irs-watch-out-small-fry/

http://654advisors.com/index.php/blog/2010/03/paul-ryans-floor-speech/

Auerback: Maginot Line Economics

This one’s too important and well written to ignore — Marshall Auerback on the credit crisis in Europe, and the policy fetishism (and its historic roots and parallels)  that’s prolonging and worsening the consequences: http://www.newdeal20.org/2010/04/12/the-piigs-problem-maginot-line-economics-9697/

A brief “What happened?!”

It was a tough day in major equity indices yesterday, with the S&P 500 down over 2%.

We don’t think it had much to do with the Senate’s lengthy grilling of Goldman Sachs executives. Rather, it was mostly about the continuing sovereign crisis in Europe, especially Greece and Portgual. We think it might also have been helped along by President Obama’s remarks on deficit reduction earlier in the day, though that’s a much more controversial assertion. 

On top of Germany’s continuing hard line on support for Greece, S & P substantially lowered its ratings yesterday on the sovereign debt of Greece and Portgugal. Such actions lower the price that buyers are willing to pay for their debt in the market place. The resulting price adjustments are often exacerbated by rules governing institutional portfolio holdings and bank capital, as multiple large sellers head for the exits simultaneously. Momentum driven speculators might play a role as well. 

In turn, lower bond prices mean higher bond yields. For example, if a bond with a $100 face value pays an annual coupon of $5, its stated yield is 5%. But if the best price the bond can fetch is $50, then the yield rises to 10%, or $5 divided by $50. The yield to maturity on such a bond is even higher, since the holder eventually receives the $100 face value at maturity. 

This is trouble for Greece because a large slug of its sovereign debt matures this year, meaning that it will have to pay an exorbitantly high price (in terms of interest rates) on its new debt. If those rates are high enough that default or insolvency become inescapable, then current bond holders may not be able to recover the full face value of the bonds they own. There’s been a good deal of talk about debt restructuring, which is basically a process aimed at helping a debtor avoid a worst case outcome while containing the total damage done to creditors.

Importantly, the price adjustments did not just hit Greek and Portuguese debt, but also that of Ireland, Italy, and Spain. It’s more than a little ironic that dithering by the same governments that want banks and nations to shore up their balance sheets is having the exact opposite effect. And if that dithering continues long enough for full blown contagion effects to take hold, then the threat of the euro payments system locking up will become too large to ignore. That’s the very thing that the USD payments system faced in the wake of Lehman’s collapse and AIG’s near collapse in 2008, and which U.S. policymakers took such drastic measures to avert. Could Greece prove to be the eurozone’s Lehman, or at least its Bear Stearns? [Update 4/28/10 - We just noticed that Marshall Auerback asked a similar question on April 12th]

Ironically, Germany’s Angela Merkel has claimed that the primary motive for her country’s intransigence is to preserve the eurozone. And yet the current EMU is essentially what they’ve anted up in the high stakes game they are playing with Greece and other eurozone governments.

While we’re not huge fans of the credit rating agencies, especially given their track records during the mortgage crisis and during the twenty year bull market in Japanese government bonds, yesterday’s announcement might actually have some value when all is said and done, as long as the markets’ severe reactions act as a wake up call to European leaders. The news flow today seems to support that thesis, though only time will tell.

Meanwhile, President Obama’s remarks reminded us that the threat of premature fiscal tightening in the U.S. is still in play. We think that his call to cast a critical eye upon all federal expenditures and carefully address longer term structural deficits is absolutely appropriate (just as we think it’s fair for the German electorate to raise similar questions about Greece). However, we’re concerned that he might be a victim of the same budget surplus fetishism that has gripped many Democrats since the 1990s.

For example, he repeated, as erroneously as ever, that the federal government’s budget is like that of any family. But in fact, the federal government’s budget is more properly thought of as a complement to family and private sector budgets in the U.S. For example, if the private sector desires to increase it savings, the public sector should run larger deficits, all else equal. And if the public sector does not fully accomodate this desire, one likely result is higher private sector leverage (debt). We’re careful to point out that this dynamic is complicated by global effects — but it should still sound familiar to anyone who was awake during the past decade or two.

Amazingly, the same budget fetishists who continue to decry ”crowding out” effects in borrowing ignore those same effects when it comes to saving. 

Until the President and policymakers demonstrate a better grasp of this, our call for long term USD strengthening remains on the table. And if stringent fiscal reforms are accompanied by a Fed tightening cycle, watch out. This isn’t likely to unfold until 2012-2013 (late 2011 at the earliest). However, it’s important to point out that underlying demographic cycles have the potential to make things all the worse, perhaps along the lines of a 1937 redux.  

IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC is a state registered investment advisor. The foregoing information is for informational, educational, or entertainment purposes only. It does not constitute an offer to buy nor a solicitation to sell any security, or to engage in any investment strategy. Symmetry Capital Management, LLC is an Amazon.com associate, and earns a commission on sales generated through links from our website. At the time of writing, some of the firm’s clients own shares of Alpha Bank (ALBKY), National Bank of Greece (NBG), and Currencyshares Euro Trust (FXE). One of the firm’s principals owns shares of Goldman Sachs (GS). The firm, its clients, and its principals do not hold any positions in Lehman Brothers, AIG, or the debt of any sovereign issuers mentioned.

URLs:

http://preview.bloomberg.com/news/2010-04-27/greece-s-junk-contagion-pressures-eu-to-broaden-bailout-after-market-rout.html

http://www.newdeal20.org/2010/04/12/the-piigs-problem-maginot-line-economics-9697/

http://seekingalpha.com/article/200708-greece-will-have-the-last-laugh

http://www.newdeal20.org/2010/03/30/greece-and-the-eurozone-angie-aint-it-time-to-say-goodbye-9235/

http://www.cnbc.com/id/15840232?video=1478940638&play=1

http://www.whitehouse.gov/omb/blog/10/04/27/Laying-the-Path-to-Fiscal-Responsibility/

Over $1,700 in 3 days for United Cerebral Palsy!

A heartfelt thank you to everyone who helped us raise funds for United Cerebral Palsy this week. We surpassed our goal of $1,200, and including our matching funds, managed to raise over $1,700 in just three days. We could not have done this without the help of each and every person who donated!

If you are still interested in making a donation, the website will remain up for some time after the race, and we are now offering a $5 match for each additional donor: http://ucpphila.donorpages.com/5KRun2010/SymmetryCapitalMgmtLLC/

Again, thank you very, very much for helping to support this important organization.

Donations still needed for United Cerebral Palsy!

We’re still looking for donors to UCP of Philadelphia & Vicinity for tomorrow’s 5K. Please consider a gift, whatever the size.

To donate, please visit our fund raising page: http://ucpphila.donorpages.com/5KRun2010/SymmetryCapitalMgmtLLC/.

In order to meet our goals, we need 25 more donors, and an additional $570 (if you’re wondering about the math, a donation of $20 that was made yesterday is not shown on our page yet). If donations reach $1,200, we will contribute an additional $300.

Please help this wonderful organization, and/or pass the link along to anyone who might be willing to chip in a small amount! Thank you!!!

Good advice for parents & students

BNET is carrying a good column by Cait Murphy (an Amherst alum by any chance?) on whether it pays economically to attend an elite university. After citing some poll data and a couple of empirical studies, she boils their findings down to:

For those who do not have a vocation for something like the ministry and are interested in earning as much as possible (be honest!) in economic terms, it probably makes sense to suck it up and go to an elite school, if you can. If you are lower income, definitely do so. ..

If the super-selective colleges don’t seem to want you for some reason, the evidence is that there is no reason, economically, to go to an expensive private one.  So financially savvy parents not averse to bribery might cut a deal along these lines:  Go to State U instead of Middling-and-Expensive Private U and we’ll throw in a car.  Or a summer in Europe.  Or both.

However the numbers are sliced and diced, though, one other thing is clear:  Character, ability, career choice and of course serendipity also matter.  Warren Buffett went to Nebraska, for example;  Steve Jobs dropped out of Reed, and Steven Spielberg went to Cal State Long Beach when the USC film school rejected him – repeatedly.

The list of (sometimes wildly) successful dropouts is much longer than this — something to keep in mind should your child decide to take a less beaten path.

Cait raises a few more good points.

First, a smart choice of school depends critically on your chosen profession. I’ll never forget a New York Times article I read a few years back about some young adults with pedigreed, six figure Master of Fine Arts degrees who were unable to afford the debt service on their student loans (yet another example of the horrible disservice we do by not providing primary financial education to all students). In the end, the price tag on an education should make sense based on well grounded expectations for future income.

Second, she writes that “in general, if you are good at math and choose a major to match, you are going to do very well indeed. The top majors in terms of high salaries, according to PayScale, are aerospace engineering, chemical engineering, computer engineering, electrical engineering, economics and physics.”

And third, ”all of these studies measure the effect of bachelor’s degrees. With more and more students going on for higher higher education, it might well turn out that the best strategy, economically, is to excel at a state university, then treat yourself to an elite law degree or MBA.”

URLs:

http://blogs.bnet.com/career-advice/?p=751&tag=col1;post-751

IRS (still) has control issues

One of the major challenges to running a modern organization is having effective accounting controls in place. In fact, for the foreseeable future, the most effective control systems could actually prove to be a source of durable competitive advantage (though technology, learning curves, imitation, and innovation should eventually erode it away).

Apparently this has been a challenge even for the IRS:

Internal accounting errors by the Internal Revenue Service reduced federal funding available for unemployment benefits by $63 million, according to a new report…

While the IRS has improved its reporting of expenses associated with administering the fund, it still lacks sufficient controls to ensure that costs are calculated accurately. TIGTA found that the IRS overstated its expenses by $63,368,413 over a five-year period. These excess funds were transferred to the General Fund for overall federal government operations instead of remaining in the Unemployment Trust Fund.

URLs:

http://www.webcpa.com/news/IRS-Shortchanged-Unemployment-Funds-53904-1.html

Please support our UCP 5K team!

We are sponsoring a corporate team again this year in the 5K for United Cerebral Palsy of Philadelphia & Vicinity. This is a tremendously important organization that helps families and individuals who face serious challenges every day to live more comfortable and productive lives. You can read more about the event at http://www.ucpphila.org/events/2010-5k, and about the organization at http://www.ucpphila.org/.

We hope that readers will consider making a donation via our fundraising page: http://ucpphila.donorpages.com/5KRun2010/SymmetryCapitalMgmtLLC/

Our goal is to reach $1,200 from 40 or more donors. Our firm will be contributing additional funds based on the number of donors and the amount raised. Granted, we’re not the size or type of firm that was central to the financial meltdown, but if you’ve ever wanted to influence what a financial institution does with its capital, here’s your chance (smile).

We sincerely appreciate your consideration. Any amount will help.

SEC’s Goldman bombshell

The SEC has filed a civil complaint against Goldman Sachs alleging fraud (yes, the f-word) for synthesizing an asset backed security related to residential mortgage loans in 2007. It was done for one of Goldman’s prize clients — John Paulson’s hedge fund, which returned billions of dollars to partners as the wave of mortgages security downgrades and defaults broke (and according to some authors, alerted Goldman to looming problems in mortgage markets) – so that he could take a large short position in (i.e., sell) U.S. mortgage securities.

The rub is that every short seller requires a buyer. And the SEC complaint alleges that Goldman’s and others’ disclosures to buyers were not above board.

There are many, many angles to this story — reputational risk, the firm’s culture and political capital, effects on pending financial regulation, implications for other investment banks and certain hedge funds — the list goes on. We think there are two quick takeaways worth thinking about:

First, the episode illuminates the dark side of financial innovation. There are actually grounds in financial theory for defending creation of this type of product. But it’s apparent that such innovations create serious agency risks for the parties involved. And the SEC is alleging that Goldman did not manage those risks effectively.

Second, we can use the event to cast a different light on the idea of “too big to fail.” At least in this case, the problem appears to have been that Goldman was too big to conduct itself ethically. We’ll leave it to readers to debate whether  “greedy” should be substituted for “big”. In the meantime, the market has been vomiting Goldman shares since the news broke.

URLs:

http://sec.gov/news/press/2010/2010-59.htm

IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC is a state registered investment advisor. The foregoing information is for informational, educational, or entertainment purposes only. It does not constitute an offer to buy nor a solicitation to sell any security, or to engage in any investment strategy. At the time of this writing, neither the firm nor its clients own shares of stock or any securities issued by Goldman Sachs. One of the firm’s principals owns shares of Goldman Sachs common stock. 

IRS: Watch out, small fry

From WebCPA:

“IRS to Step Up Audits of Sole Proprietors”

“IRS Reduces Audits of Large Corporations”

As bad as it sounds, this could be the natural progression of a long term enforcement effort, though we’re only speculating on that possibility. It’s also valid for the IRS to enforce existing tax laws regardless of the size of a business. The core problem, as described by a subject in one of the articles, is that the tax code’s complexity imposes a heavier relative burden on smaller businesses, and (we would add) real opportunity costs on society. That’s especially true when innocent firms are subjected to an intensive audit.