REPORTING, REGULATING, AND CONTROLLING DERIVATIVES

Derivatives have been a hot item in the press over the past several years. They have taken the blame for some of the largest financial losses since the savings and loan crisis of the '80s. To help protect the public from additional exposure to their volatility, various organizations have been at work. First the FASB, as part of its broad financial instruments project, has sought to improve the financial reporting of those investing in derivatives to better disclose the risks they are taking. The FASB's latest standard on the subject is SFAS No. 119, Disclosure About Derivative Financial Instruments and Fair Value of Financial Instruments, which is effective for 1995 calendar year-ends for entities with less than $150 million in total assets. Entities with more than $150 million in assets had a year earlier effective date.

Second, the U.S. General Accounting Office has made a comprehensive review and analysis of the nature of the derivatives markets and the need for further governmental regulation. The GAO's report on its analysis has become the "bible" on derivative trading. The GAO has recently made recommendations to the SEC for improvements in the reporting of publicly held companies that invest in derivatives.

Third, those making a market in derivatives, such as Salomon Brothers, Inc., have analyzed the kinds of risks inherent in their trading and the internal controls that should be in place to minimize exposures to those risks.

In this month's issue of The CPA Journal, those three aspects of derivatives‹reporting, regulating, and controlling‹are presented in three different ways. In the first article, Jan Williams and Tim Eaton explain the nature of derivatives and the new disclosures requirements of SFAS No. 119. In the second article, managing editor James Craig interviews the GAO's chief accountant Donald Chapin to learn of the work of the GAO and its recommendations. Craig also uses the interview to learn of some of the other GAO projects that are of interest to accounting professionals. One such project is its review of the profession's responses to various recommendations that have been made to make the profession more responsive to the public interest.

In the third article, Kenneth Marshall, head of the internal audit function at Salomon Brothers, discusses some of the recently publicized cases‹Orange County and Barrings‹of huge losses that have been blamed on derivatives and the kinds of controls that should be in place to prevent them from happening. He also explains some of the self-regulatory efforts by the investment banking community to protect the public. *

DOLE AND PRYOR INTRODUCE FAMILY BUSINESS PRESERVATION LEGISLATION

On July 28, Senators Dole (R-KS) and Pryor (D-AR) introduced the "American Family-Owned Business Act," (S. 1086) to reduce the estate tax burden on family-owned businesses. The proposed legislation provides for an exclusion of $1.5 million and a 50% tax reduction for the value of a business over $1.5 million. The bill is not simple; but it is a significant extension of current provisions targeted to preserve family-owned businesses.

The bill would only apply where one family owns 50%, two own 70%, or three own 90% of a business. No part of the equity or debt of the business can have been publicly traded during the preceding three years. The business must have a principal place of business in the U.S. No more than 65% of the business' income can have been personal holding company income. And none of the tax benefit can apply to cash or marketable securities in excess of that needed for day-to-day running of the business.

To fall within the provision, the value of the business must be 50% or more of the decedent's gross estate. The decedent or a family member must have materially participated in the business during 5 of the 8 years preceding the decedent's death.

Also a family member must continue in the active management of the business for at least 10 years after the date of death or until the surviving family member's death. In the event this condition ceases to be met, the tax benefit must be repaid at a favorable 4% interest rate. *

AICPA SEEKS SOLUTION FROM FEDS

In News & Views in the August issue of The CPA Journal, it was indicated that the AICPA had not yet issued guidance on revised wording of auditor's reports for audits conducted under OMB Circulars A-128 and A-133. New wording is required to conform auditor reporting to the 1994 revisions to Government Auditing Standards (the Yellow Book). AICPA vice president, Joseph Moraglio has informed the Journal that the AICPA has issued revised wording for the auditor's report relative to the audits of the financial statements, and auditors may use such wording. Illustrative reports are available from the AICPA Fax Access Hotline by dialing (201) 938-3787 from a fax machine, following the voice cues, and selecting document 309 (for state and local government reports) or document 476 (for not-for-profit reports). With respect to reports relative to Federal financial assistance, the AICPA has requested the Office of Management and Budget--the office responsible for revising circulars--and the inspectors general to either revise the circulars to conform with the new Yellow Book or to permit auditors to use reporting language that satisfies the Yellow Book. For various reasons, the revisions have not been made. Accordingly, auditors should continue to use the reporting language as required by the two OMB circulars. *

ACCOUNTING AND REVIEW SERVICES COMMITTEE VOTES FOR ASSEMBLY SERVICE

By a tally of 6-1, the AICPA Accounting and Review Services Committee voted to issue an exposure draft that would have the effect of introducing a new level of accounting service to the CPA's portfolio. The proposed statement, Assembly of Financial Statements for Internal Use Only, borrows from the attestation standards for financial forecasts and projections by introducing the concept of assembly to historic financial statements. The exposure draft defines an assembly as follows:

Providing various manual or automated bookkeeping or data processing services the output of which is in the form of financial statements intended for internal use only. The function of assembling financial statements may include preparing a working trial balance, assisting in adjusting the books of account, and consulting on accounting matters. Assembly does not refer to the mere typing or reproduction of client- prepared financial statements.

Under the proposed statement, an assembly service is only appropriate for unaudited financial statements that are reasonably expected not to be used by a third party. If that is the case and the accountant has not been engaged to compile or review the unaudited financial statements and the client represents in writing that the financial statements are not expected to be used by a third party, the service would be exempt from the provisions of Statement on Standards for Accounting and Review Services (SSARS) No. 1.

The proposal would require a written understanding of the services to be performed and a confirmation of management's representation and agreement that the financial statements are for internal use only. The ED presents suggested language for the engagement/representation letter. It also suggests an optional paragraph for the letter under which the client would agree not to take, or assist in, any action seeking to hold the accountant liable for damages on account of any deficiency in the financial statements assembled by the accountant and the client would agree to indemnify and hold the accountant harmless from any liability and related legal cost arising from third-party use of those financial statements in contravention of the terms of the engagement letter.

The ED would allow for two other optional items.

* A reference on each page of the financial statements such as "restricted to internal use only--see engagement letter dated [date]."

* The use of a transmittal letter with the assembled statements which would be limited to--

1. an indication the financial statements are enclosed,

2. a reference to the fact the statements are for internal use only, and

3. comments of a business advisory nature.

The deadline for receiving comments‹which are expected to be numerous‹on the ED is December 31, 1995. It is ironic that the standards for a new, lowest-level of service, would be the only standard requiring an engagement letter, the highest level for establishing the terms of an engagement. There are many issues contained in this rather short proposed statement. Would the exemption from SSARS also exempt the service from self-disciplinary activities such as peer review and the AICPA Code of Conduct? Nowhere in the proposed language does the accountant providing the service refer to professional standards of any kind. Would the service be considered the practice of public accounting and therefore subject to state licensing and disciplinary proceedings?

The proposal is an attempt to give CPAs the tools to better serve clients and compete in the marketplace. But there is a risk that it will have the reverse effect by removing that which distinguishes the work the CPA does from unlicensed practitioners and commercial preparers. All practitioners are encouraged to review the proposal and respond to Tom Kelley, Group Vice President­Professional, at the AICPA. *

IRS ISSUES DOCUMENT BRIEFING ON PARTNERSHIP COMPLIANCE EFFORT

Following an internal teleconference, the IRS released a background briefing document that identifies the 11 areas in partnership taxation considered to be key emerging issues.

The 11 issues are‹

* abuses under the new anti-abuse regulation, Treas. Reg. Sec. 1.701-2,

* disguised sales covered by IRC Sec. 707,

* allocations under IRC Sec. 704(b),

* issues under IRC Sec. 704(c) and 737,

* family limited partnerships, IRC Sec. 704(e),

* allocations under IRC Sec. 736,

* determination of partnership versus joint venture status,

* withholding of tax on foreign-held partnership interests,

* basis allocation from recourse liability under Treas. Reg. Sec. 1.752-2,

* basis allocation from nonrecourse liability under Treas. Reg. Sec. 1.752-3, and

* cancellation of indebtedness issues. *

BOOK REVIEW: BIG BETS GONE BAD: DERIVATIVES AND BANKRUPTCY IN ORANGE COUNTY

By Philippe Jorion, Academic Press, 156 pages, $19.95.

Reviewed by John F. Burke, CPA

In reality, this book is a combination of two books. The first provides background on how the Orange County investment pool lost $1.7 billion dollars and caused Orange County to seek bankruptcy. And since derivatives are believed to be the cause of the bankruptcy, the second book within a book is a textbook on derivatives. The interesting aspect of this approach is that the book clearly shows derivatives were not the cause.

The real culprit was the approximately $13 billion of repurchase agreements (repos) entered into by Orange County Treasurer Robert Citron to leverage the investments of the pool. Under the terms of these agreements, the pool sold securities to investment banks with the agreement to repurchase them within a short period of time. While the author tries to make the point that such an agreement can be viewed as a forward contract and therefore a derivative, he also clearly indicates the repos are nothing more than a secured borrowing. In effect, Citron borrowed on a short-term basis to invest in long-term securities. This practice, to survive as an investment approach, depends on interest rates remaining stable or decreasing. In February 1994, the Federal Reserve started a series of interest rate increases that drove down the value of fixed-rate securities. With the decline in value of the securities under repos, the investment banks demanded additional cash for margins on their loans. The pool soon ran out of cash, and in December 1994, one of the investment banks sold its collateral when the pool couldn't make its payment. This started a run by all but one of the other investment banks. Faced with this run, Orange County decided to declare bankruptcy. The sale of the collateralized securities led to an immediate loss of $1.3 billion dollars with the rest of the loss being suffered when the remainder of the pool was liquidated.

The pool did invest in securities classified as derivatives, and the loss on these securities was part of the overall loss. However, the real problem was in an investment strategy that assumed interest rates would stay the same or go down. When these investments had to be liquidated, the losses had to be recognized. It should be noted that Citron's other strategy was to hold securities to maturity, and he was apparently happy with the fact he didn't have to book "paper" gains and losses.

In one brief section, the author states erroneously that there were "four independent audits in 1994." The first was a meeting the SEC held with Citron and his deputy, the second involved credit agencies affirming their ratings, and another was an apparent non-audit by the county auditor. The closest thing to a real independent audit was one performed for the year ended June 30, 1994, where the report was never issued because of the bankruptcy. Elsewhere a county supervisor is quoted as stating that the 1993 audit should have been a huge red flag, but the author did not follow up on this.

For a CPA, the discussion on derivatives and other financial instruments is a mixed bag. Since it is written for non-sophisticated readers, the explanations start out in very basic terms. They sometimes go to the other extreme and delve into areas about which very few people want to know. The explanation of the causes of the bankruptcy, however, are interesting and informative. The author comes to the right conclusions. Derivatives are not the problem. There is always an element of risk in investments. The problem arises when there are no controls over the people making (and not understanding) these risk decisions. *

FIGURES NOW AVAILABLE

In the May issue of The CPA Journal, Kathryn Savage, Bob Kilpatrick, and Craig Bain presented the results of research they had done on how practitioners evaluated conflicting authorities in assessing the realistic possibility standard. The authors pointed out tax practitioners are subject to various penalties and sanctions designed to ensure proper positions are recommended on their clients' tax returns. The IRS, the AICPA, and the American Bar Association have all established a "realistic possibility" standard as a benchmark for recommending tax return positions.

To help readers interpret the results of the study, the authors prepared five figures graphically showing practitioners' judgments. The figures were referred to in the article but were inadvertently not published. The Journal's production department has prepared a revised version of the article which includes the figures. Copies of the article are available by writing or faxing The CPA Journal, attention of the managing editor. *

REGULATORY BULLETIN EXPLAINS OTS AUDIT POLICY

A bulletin issued by the Office of Thrift Supervision (OTS) spells out when a savings association or thrift holding company must have an independent audit and the procedures to be followed.

Regulatory Bulletin 32-1 provides the first detailed guidance on independent audits since OTS revised its audit regulation last November.

That regulation, designed to make audit rules for savings associations more consistent with those for commercial banks, takes into account an FDIC rule requiring annual independent audits for thrifts and banks with assets of $500 million or more.

OTS retained authority to require an independent audit of any savings association or thrift holding company, regardless of size, if an audit is needed to address safety and soundness concerns. Regulatory Bulletin 32-1 identifies the circumstances when OTS will require such an audit.

Associations with a certain examination rating are automatically required to obtain an independent audit. Otherwise, associations can expect to get a written notice from OTS when an independent audit is required for other safety and soundness purposes. Safety and soundness concerns that may cause OTS to require an audit include questions about the reliability of financial information submitted by a thrift institution and deficient internal financial reporting controls. Suspected insider abuses, theft, or other suspected criminal activity may also trigger an OTS notice for an independent audit.

The bulletin describes the grounds on which an institution may request a waiver of the audit requirement. OTS will consider granting a waiver if the audit is not likely to help solve the problem that led to the poor rating.

Thrift Bulletin 32-1 makes clear that even for those institutions not required to have an annual independent audit, such a practice is still a good idea and is encouraged by OTS.

Thrift holding companies must have an annual independent audit if the holding company controls subsidiaries that have aggregate consolidated assets of $500 million or more.

The bulletin reduces regulatory burden by rescinding seven Public Accounting and Internal Audit Bulletins issued by the OTS. Associations are no longer required to file engagement letters, change in audit notices, or voluntary audit or agreed-upon procedure reports with OTS. Nor are associations required to provide OTS a reconciliation in the financial statements of GAAP capital to regulatory capital. In addition, the audited financial statements of the association's holding company will be accepted by OTS in lieu of separate financial statements from the subsidiary savings association. Thrift Bulletin 32-1 was mailed to all OTS-regulated savings institutions in late August. *

UNAMORTIZED ACCOUNTING METHOD CHANGE HELD TO BE "BUILT-IN GAIN" ON ELECTION OF S CORP STATUS

The U.S. Tax Court has held that the unamortized portion of the adjustment mandated upon the change of an accounting method is a built-in gain that must be recognized at the corporate level after election of S corporation status.

IRC Sec. 1374 places a corporate-level tax on S corporations to the extent that they recognize built-in gains that existed at the time of the S corporation election. In general, a built-in gain is any income earned while the corporation was a C corporation but has gone unrecognized before conversion to S corporation status. Examples of built-in gains are the difference between cost and fair market value of inventory and other tangible and intangible property and unrecognized accounts receivables. The tax is imposed at the top corporate rate on any built-in gains that are recognized during the ten-year period following conversion to S status, called the "recognition period."

In this case, the taxpayer had changed from the cash to the accrual method. The change was mandated because the taxpayer maintained inventories. As a result of the change, the taxpayer was required to take a total of $1,336,967 into income over a period of six years. In the fourth year, the corporation elected to be an S corporation. The corporation had hoped to pass the remaining three years of the accounting change amortization through to the taxpayer without paying a corporate-level tax. The IRS took a dim view of this approach and assessed additional tax.

The court noted, "IRC Sec. 1374(d)(5) provides that any item of income properly taken into account during the recognition period, which is attributable to the period before the subchapter S election, shall be treated as recognized built-in gain" [emphasis in original]. The taxpayer's chief line of defense was that Treas. Reg. Sec. 1.1374-4, which reaches the same result as the court, had an effective date after the date of its election. The taxpayer went on to assert that because of the regulation's later effective date, the IRS was without authority to assert the IRC Sec. 1374 tax. The court was not persuaded and noted that it was able to interpret the built-in gains tax rules based on the statute and legislative history in the absence of regulatory support.

Source: Argo Sales Co., Inc. v. Commissioner, __ TC __, Doc. No. 16072-93 (8/2/95). *

TO SUE OR NOT TO SUE‹THAT IS THE QUESTION

By Leon Lebensbaum

I am a dual practitioner--an attorney with a concentration in taxation and a partner, with another, in a small CPA firm. Almost five years ago, the accounting practice acquired an attorney as a client on a contingency basis. Basically the issue involved penalties for late filing.

After achieving an abatement of these penalties, the client refused to pay the fee under the contingency retainer agreement, which amounted to approximately $14,000. He completely ignored our telephone calls and letters. Had he approached us, we would have made a sizable reduction in fees for expediency. Angered by his ignoring us, we began a lawsuit.

The client counterclaimed for $3 million, alleging malpractice. This elevated the case to the Supreme Court. He alleged that he, not us, had accomplished the penalty abatement and that, among other things, his sex life was destroyed.

Of course the malpractice suit brought both the accounting and legal insurance carriers into the picture. Initially the insurance lawyers sounded us out on the possibility of their paying the client a nuisance settlement of about $5,000 to resolve the entire case. We declined to drop our suit, knowing that we had done nothing wrong and there was absolutely no evidence to support those malpractice charges. Our reputation was important.

We estimate the insurance companies expended approximately $75,000 in legal fees. We devoted days to examinations before trial and related conferences. On the eve of trial, the client dropped all of his malpractice claims. We then proceeded to trial on our original fee claim. The Supreme Court judge who tried the case informally expressed outrage over the fact he had to preside over a case which involved a relatively small amount of money because we declined his offer to arrange a settlement for approximately 60% of what we claimed was owed.

After a 3-day trial (which required the client to engage his own attorney, required us to engage an expert witness, and subjected my partner and me to a lengthy and intense cross-examination), the jury brought in a unanimous verdict in our favor for the full amount we sought. Probably the most important piece of evidence was our clear and explicit retainer agreement. In their comments afterward, the jurors indicated that they realized that we were motivated by principal, not by money.

We now have a record with our insurers, although their attorneys confirm that in no way were we at fault. In addition to conferences, days of EBTs, and other preparations for the trial, we are left with billings from our own attorney and expert witness (who knowing the circumstances, reduced their fees), which nevertheless exceeded our award, plus interest.

Obviously something is wrong with a legal system that permits a client to do what he did. It also results in increased insurance premiums that all of us pay.

We were left pondering the question: Does principal justify a pyrrhic victory? For us the answer is yes. *

TREASURY OPPOSES AICPA WORKLOAD COMPRESSION INITIATIVE

At the miscellaneous tax provisions hearing July 11 and 12, Assistant Secretary for Tax Policy Leslie Samuels testified against H.R. 1661, the AICPA-sponsored workload compression bill. Despite Treasury's opposition, Congressional support for the bill has multiplied since the hearing. In Samuels' written statement issued July 28, he said the following:

Issue: Allow partnerships and S corporations to elect taxable years other than required taxable years by paying estimated taxes on behalf of their owners

Administration Position: Oppose. This provision is extremely complex and will impose greater administrative and compliance burdens on the IRS. Furthermore, there are a number of technical problems. For example, the entity makes payments at the corporate rate, unless owners have income from the entity above a certain amount, or, if the entity is a partnership, it has income above a certain amount without regard to the number of partners. This may result in significant deferral of estimated payments by the owners, depending upon their tax brackets. As another example, the owners may find it difficult to determine the actual amount of credit against their own tax liabilities that is flowing from the entity if ownership is changing throughout the year. *

BOOK REVIEW:
ACCOUNTING FOR EFFECTIVE DECISION MAKING

By Martin Mellman, PhD, CPA, Joseph Kerstein, PhD, CPA, and Steven B. Lilien, PhD, CPA, Irwin Professional Publishing, 510 pages, $50.00

Review by Alexander A.H. Bohtling, CPA, retired from Deloitte & Touche LLP

Accounting for Effective Decision Making is designed for nonfinancial executives and those not possessing extensive knowledge of accrual accounting and the complexities of taxation. It is also appropriate for those moving up the corporate ladder who will be called upon to use accounting information in their decision making.

The book is written for executives of both privately-owned and publicly-owned companies. The reporting requirements, internal and external, are well covered. The SEC requirements are briefly but well explained. Industry issues are also taken into consideration, and numerous exhibits from reports of specific publicly-owned companies are presented.

The book consists of nine chapters, namely: understanding external reporting for effective use and communication of financial data, accounting principles can impact your company's reported financial results, selected topics in financial accounting, analysis of financial statements, accounting information and corporate organization, internal reporting systems, marketing cost determination and reporting, planning and control, and managerial performance assessment. These include the subjects of budgeting and strategic planning.

As the book points out, publicly held companies must include a management discussion and analysis section in their registration statements, as well as in their annual reports. This necessitates management's knowledge of the underlying data, and the application thereto of generally accepted accounting principles.

In your reviewer's opinion, this book provides practical guidance for decision making by corporate management and is a useful source of reference for practicing CPAs. *

GOVERNMENT PREPARES FOR SHUTDOWN

The government's fiscal year begins October 1. Before then, Congress needs to pass and the President needs to sign 13 appropriations bills and a budget bill if they are to carry on after September 30. In addition, it is expected that we will bust through our national debt ceiling by mid-October. Congress needs to pass and the President needs to sign a new debt authorization bill if the government is to continue deficit spending after that date.

Yet, Congress and the President, at this writing are on a collision course. The President wants to balance the budget in 10 years, nine if he is pushed. In addition, he refuses to sign a tax cut bill that "benefits the rich." Congress insists on achieving a balanced budget in seven years and is convinced those tax cuts are being demanded by the electorate.

The President's people are exploring ways to continue the government's operation if either Congress fails to deliver appropriations bills or the President cannot stomach signing them. Congress can authorize the President to carry on business with a "continuing resolution." Two have been introduced by Rep. George Gekas (R-PA), H.R. 2006, that provides automatic continuing resolutions for any appropriations areas not passed in time; and H.R. 2007, which would permit the government to continue collecting revenues in the event the government shuts down.

The President's people are studying the implications of a 1981 legal opinion written by the Carter administration's Attorney General. That opinion was used by the Bush administration, during the three-day shutdown of the government that occurred in 1990. That memo concludes that the President is empowered to keep the government operating in the face of imminent threat to person or property. Determining what constitutes imminent threat to person or property is under study.

Regardless of how events unfold, the country will be treated to some raw drama in governance. *

IRS RULES JUST-IN-TIME SETUP COSTS MUST BE CAPITALIZED

In an as-yet unpublished technical advice memorandum, the IRS has ruled that the costs incurred in initially adopting a just-in-time (JIT) manufacturing process must be capitalized. The technical advice reportedly pertains to the Danaher Corporation of Washington and $800 million of expenditures is at issue.

JIT manufacturing involves a philosophical change in how products are manufactured, in this case creating vertically integrated "cells" to effect "flow production." This approach provided long-term benefits to the taxpayer, permitting it to significantly reduce its parts inventory.

The taxpayer incurred costs for relocating and reconfiguring existing equipment, materials, and supplies for setting up the JIT process, training of labor and management, and consulting. The IRS, in what may ultimately turn out to be an overly conservative ruling, held that each of the four cost areas mentioned must be capitalized. There was no discussion of whether the costs are properly amortizable, but it would appear that if the IRS's analysis stands, there would be no ascertainable life over which the costs of initiating a JIT manufacturing process could properly be amortized.

Regarding the costs to relocate equipment, the IRS acknowledged a number of cases that held such costs were generally deductible. Nevertheless, the IRS relied on Addressograph-Multigraph Corp. et al. v. Commissioner, a 1945 Tax Court memorandum decision, that held costs of installing a new production system were capital in nature. To hold the materials and supplies capitalizable, the IRS relied on Treas. Reg. Sec. 1.263(a)-2(a), which states that expenditures having a useful life substantially beyond the end of the taxable year must be capitalized. In this case, the taxpayer agreed there was a useful life to the supplies and materials extending beyond the taxable year.

Concerning the training costs, the IRS relied on cases pertaining to training of employees in the start-up phase of a business to hold the training costs to start-up a JIT process to be capitalizable. And again, an IRC Sec. 263 analysis was used to hold the consulting costs to be capitalizable.

Reportedly, the taxpayer involved in this technical advice has turned to its political representatives in Washington, pointing out that foreign manufacturers, including those in Japan who pioneered the JIT manufacturing process revolution, are able to deduct these costs. A nondeductible treatment for U.S. firms places the U.S. concerns at a competitive disadvantage.

Source: TAM ____ (July 21, 1995) *

FLAT TAX: AN ENORMOUS ADDITION TO FEDERAL COFFERS

I have just finished reading Mr. James A. Fellows' article, "A Conceptual Analysis of the Flat Tax," in the July 1995 issue.

In the section entitled, "Will the Flat Tax Decrease Tax Avoidance and Evasion?" Mr. Fellows has omitted a huge possible positive result for our economy and for the Federal treasury. As a "grassroots" practitioner, I can only guess, not only as to the amount of presently untaxed income that would be reported, but as to the untold billions of previously legitimately earned, but untaxed cash sitting in mattresses and safe deposit boxes gathering dust. At a 20% flat-tax rate, it would be possible, at a modest 6.5% rate of return, to recoup the tax paid on cash reported as current earnings over a short three-year period. So that, after the initial tax hit, the hidden and unutilized cash would now be a legitimate part of an individual's net worth and be working for him.

I think it would be impossible to estimate the effect on the economy of the initial investment in savings and business capital that such an influx would have, as well as the enormous addition to our Federal coffers. *

Jeffrey Burstein, CPA

Burstein & Burstein

\THE FLAT TAX‹A CPA ANSWERS BACK

The flat tax could destroy what is left of an already declining system. This is another example of misplaced blame by the politicians, trying to find a diversion for other major problems that are not being handled correctly, i.e., the deficit, balance of payments, welfare reform, etc.

In the first place, the present tax system works and is accepted by the American people. Second, we have advanced to the point where record keeping is almost automatic. Even the smallest of companies can afford and handle a computerized bookkeeping system. The government also maintains a completely electronic system and a complete taxpayer help system that answers most taxpayer questions online. Technology has the potential for making the present tax system much less burdensome.

The flat tax is a meaningless measure. It calls for everyone to be taxed at one rate, say 17%. But the real question is 17% of what? Do we just place any number for income (it sounds simple)? But you know, you have to put in wages, next is interest and dividends, capital gains/losses, partnership distributions, and real estate income. In other words we have to account for "income"; we cannot just put down any figure!

But wait one second! You mean because I am married with a family, several dependents, doctor bills, a house and mortgage, college education for children, care of elderly parents, and retirement funds to be set aside, I should pay the same tax as the single, free spending, no responsibilities and obligations individual? The existing system, after all, is really very simple. Isn't it the tax program that created all the retirement and pension plans, with their trillions of dollars?

As a CPA-tax preparer, naturally, I do not relish the idea of being put out of business, which was built over 20 years. But I see it another way. To me, tax preparation is a part of my services, but the tax return is not the only objective. In consulting with my clients, discussing their personal problems, business and investment matters, my suggestions play an even more important part in their affairs. My years of experience have given me valuable insights that have helped many save hundreds of thousands of dollars through proper tax, retirement, and estate planning.

The problem is not the tax system but what we are doing to it. We keep eliminating and reducing deductions in many little ways that creep into the tax system. In reality these are tax increases, i.e., 2% reductions of itemized deductions, for one; elimination of personal interest deductions, etc. If this happened to business, you would hear an outcry that would be heard to the moon. *

Stanley Simon, CPA

Own Account

FLAT TAX: NOT REGRESSIVE BY NATURE

While I agree with Dr. Fellows' conclusion that a flat-tax rate is not, by definition, regressive, the nature of all or most of the proposals currently being considered in Washington, D.C. is regressive.

The only specific proposal outlined in the article is one put forth by Representative Richard Armey, which Dr. Fellows notes would exempt interest and dividend and capital gains incomes, which are disproportionately received by wealthier taxpayers. Dr. Fellows' calculations, which show progressivity under a flat tax by assuming a fixed level of exclusions and deductions from economic income, would present the opposite result if the level of exclusions grew as income increased. In the article, Dr. Fellows reveals the hypocrisy of the existing "progressive" tax system, but fails to clearly state that most of the flat-tax alternatives, such as Armey's, contain provisions which would likely produce a similar redistribution. *

Michele Mark Levine, CPA

OCTOBER 1995 / THE CPA JOURNAL