CA State Slush Funds Flush With Cash

As California politicians begin begging for increased tax revenues, new reports show that the state's 500-plus obscure special funds are raking in funds:

California now spends nearly $40 billion on special fund programs, more than every state except New York and Texas spends on its entire general fund. The special fund money pays for an amazing array of services, from major priorities such as mental health, hospital construction and highway repairs to obscure things like bingo halls, acupuncture and midwifery.   Fees like the cost to enter a state park or the 5-cent recycling fee on a soda can -- not your taxes -- fuel the state's special funds. Yet more and more, the state is borrowing billions of dollars from these special accounts to balance the general budget used to fund such things as education and prisons.

Usually out of the spotlight, special funds make up one-fourth of all state spending and are now receiving rare scrutiny and will be the focus of  legislative hearings after finance officials found $54 million in funds hidden in two state parks accounts. An analysis by this newspaper showed the state's books for all the special funds were off by $2.3 billion, a discrepancy finance officials are now investigating.

The discoveries could result in political headaches for Gov. Jerry Brown as he tries to convince voters in November that the state needs tax increases to avoid massive cuts to schools and social programs.

What's the FMV of artwork that cannot be sold? IRS says $65 million

From the NY Times:

The object under discussion is "Canyon," a masterwork of 20th-century art created by Robert Rauschenberg that Mrs. Sonnabend’s children inherited when she died in 2007.

Because the work, a sculptural combine, includes a stuffed bald eagle, a bird under federal protection, the heirs would be committing a felony if they ever tried to sell it. So their appraisers have valued the work at zero.  But the Internal Revenue Service takes a different view. It has appraised “Canyon” at $65 million and is demanding that the owners pay $29.2 million in taxes.

...

At the moment, tax experts note that the I.R.S.’s stance puts the heirs in a bind: If they don’t pay, they would be guilty of violating federal tax laws, but if they try to sell “Canyon” to zero-out their bill, they could go to jail for violating eagle protection laws.

Mr. Lerner said that since the children assert the Rauschenberg has no dollar value for estate purposes, they could not claim a charitable deduction by donating “Canyon” to a museum. If the I.R.S. were to prevail in its $65 million valuation, he said the heirs would still have to pay the $40.9 million in taxes and penalties regardless of a donation.

Then, given their income and the limits on deductions, he said, they would be able to deduct only a small part of the work’s value each year. Mr. Lerner estimated that it would take about 75 years for them to absorb the deduction.

“So my clients would have to live to 140 or so,” he said.

Fresno Water Fight--CSA 51 Goes Down

On July 17th,  certain Fresno county island residents voted on CSA 51--which was a proposal to build water pipe lines bringing tap water to some 432 county homeowners in a low-yield water area.  Each of these residents would then be assessed approximately $54,000 in additional property taxes for the construction costs.  If passed, homeowners would be afforded the option to pay up front, or over the course of 30 years.

It is my understanding that the unofficial vote tally is 251 against, 97 in favor.

The vote reminds me of a recent Supreme Court case, Armour v. City of Indianapolis, where Indianapolis constructed a sewer system for a neighborhood and financed it through a tax assessment of around $9,300 per parcel.  Owners could pay it in a single lump sum or over the course of 30 years.  Several years after the assessment, the city decided to issue bonds to cover the costs and the city forgave the unpaid installments, but refused to refund any part of the upfront payments made by some 38 owners.  The Supreme Court ruled that equal protection was not violated by the city's decision to treat these taxpayers unequally.  Why?  Because it was rationally related to the city's legitimate objective of avoiding administrative inconvenience.  

NY Times: Wealthy Turn to Family Limited Partnerships

New York Times:  In an Unusual Tax Year, the Wealthy Turn to Partnerships:

A Family limited partnership was once a rather esoteric way for wealthy families to centralize the management of real estate and various pots of money. But this is not a normal tax year.

The arcane device has suddenly become popular because of the scheduled expiration of the $5.12 million gift tax exemption at the end of this year. ... But wealth advisers cautioned that the rush to set up a partnership in order to use the tax break could lead families to do something that is not right for them.

For some families, a partnership is attractive. It is a way to combine money to reach the higher investment requirements that hedge fund and private equity managers require. But its most alluring feature may be the ability to discount the value of the assets put into the partnerships because the shares distributed from it are less liquid since only another family member can buy them.

A discount of 25% generally does not attract scrutiny from the IRS, and that could allow someone to increase a $5.12 million gift exemption to $7 million. Since the partnerships are not overly expensive to administer, several advisers said they have seen people starting them with as little as $2 million. But affluent families on the lower end of that range also risk running afoul of the IRS by being too aggressive in what they put into a partnership and how much they discount it. As families look for ways to get the most out of this year’s gift tax break, many of the advisers I spoke with said they were worried that less sophisticated families would be misled into thinking that they could put everything they had into a family limited partnership and never worry about taxes.

 (See also Family Limited Partnership Video Presentation)

Gov. Brown Forces His Tax Initiative to Top of Ballot--Courts Uphold

Conventional wisdom holds that ballot initiatives listed at the top of the ballot are more likely to pass than those listed at the bottom (slothful voters get tired of reading or confused and tend to vote no).  Because Gov. Brown's tax initiative was certified late, it would have ended up on the bottom, below Molly Munger's competing tax initiative.

In order to finagle his initiative to the top and increase its chances of success, the legislature recently changed the law on how initiatives are ranked.  Now, initiatives dealing with bond measures and constitutional issues are given priority--which would place the Governor's initiative at the top of the ballot. 

This legal wrangling, which was decried by competing tax measures and anti-tax groups was recently upheld in court. 

Mandate Constitutional--3.8% Investment Tax Now On Its Way

From the WSJ on the implications of the Supreme Court's health care decision:

It really is happening.
Until this week, investors were waiting to see what the Supreme Court would do about the 3.8 percentage-point surtax on investment income, part of President Obama's health-care overhaul. The IRS hasn't yet released guidance on the new tax.
So when the court affirmed the law on Thursday, investors—and tax advisers—started scrambling.
The new tax, which Congress passed in 2010, affects the net investment income of most joint filers with adjusted gross income of more than $250,000 ($200,000 for single filers). Starting on Jan. 1, 2013, the tax rates on long-term capital gains and dividends for these earners will jump from their current historic low of 15% to 18.8%, assuming Congress extends the current law.
If, on the other hand, Congress allows the tax rates set in 2001 and 2003 to expire on Dec. 31—an unlikely scenario, according to many experts—the top rate on capital gains will rise to 23.8% and the top rate on dividends will nearly triple, to 43.4%.
Whatever the fate of the 2001-03 tax rates, advisers are telling clients to start making moves to minimize the new levy. ...
Here are answers to some basic questions about the tax:

• How does the 3.8% tax on investment income work?

• How is "investment income" defined?

• What are some examples of when the tax would and wouldn't apply?

• How would the 3.8% tax apply to the sale of a principal residence?

• What happens if a taxpayer has adjusted gross income above the threshold that is then reduced by a large itemized deduction—such as for medical expenses or a charitable gift?

• Does the 3.8% tax apply to trusts and estates?

• Doesn't the health-care law also have an extra payroll tax for higher earners?