Taxes and the Deficit

Normally, this column is supposed to cover the tax changes over the prior year and how they impact the hospitality industry. Last year, we commented about how 2010 was an interesting year but little had passed in the tax field. 2010 was all about health care reform, the change in control of the House, and the rise of the Tea Party. It was a very political and partisan year.

If anything, 2011 was worse. Never has so little been accomplished by so many. Brinkmanship was the key word for 2011. It will be known more for what did not occur rather than what did. It is not unusual for partisan politics to take center stage in an election year. While 2011 was not, the race for the Presidency and control of the House and Senate began before all the winners from 2010 were known.

Two major issues were pre-eminent during 2011. The first was the size of the deficit. To agree to an extension of the debt limit, the House (mainly the newly elected members) required substantial reductions but as a compromise, left it up to a House/Senate committee to recommend the cuts. Proposals were put forward to cut billions in spending while at the same time raising taxes. The “reform of the tax system” was not accomplished. As a result, automatic spending cuts of $1.2 trillion over 10 years are to be made. In addition, without some action, the Bush tax cuts will expire at the end of 2012, resulting in substantial tax increases for 2013.

The other issue was the extension of the temporary Social Security tax cut. For 2011, the employee share of Social Security tax was reduced from 6.2 percent to 4.2 percent. Similar reductions were made for the self-employed. However, Congress and the President were unable to agree on a method to pay to extend the benefit for the 2012 tax year. Not to be viewed as the Grinch, right before Christmas an agreement was reached to extend the tax break for the first two months of 2012.


After the New Year, the President again raised the issue of extending the break for the rest of 2012. He proposed the same method of paying for it that had previously been shot down by the Republicans. However, in a surprise move on Feb. 13, the Republicans said they would not require this tax break to be offset with spending cuts. They realized that fighting this battle was a losing cause with the American people. As a result, the Social Security tax-withholding rate for employees will remain at 4.2 percent for the remainder of the year.

Several tax issues are important for those in the hospitality industry. The IRS has established a Voluntary Classification Settlement Program (VCSP). This program will enable employers to voluntarily re-class workers for federal employment tax purposes and take advantage of audit protection and a reduced penalty framework. The VCSP is open to taxpayers currently treating their workers as independent contractors. The IRS continues its emphasis on foreign assets held by U.S. taxpayers, including additional information reporting by both taxpayers and foreign financial institutions. The penalties are severe and enforcement is active. Two provisions that passed at the end of 2010 will have an impact on the industry. They are:

– 50 percent bonus depreciation allowance for property placed in service during 2012

– Increasing the maximum expense deduction to $125,000 and setting the phase out amount at $500,000 for years beginning after Dec. 31, 2011

The President issued his budget blueprint in February 2012. The Republicans announced it dead and the Democrats see no need to pass a budget for the year. It is not expected to move forward but it does contain several tax provisions. The biggest is the expiration of the tax cuts and a minimum tax rate on all income of 30 percent for those earning more than $1 million (the so-called Buffet tax). On Feb. 22, the White House and the Department of Treasury released the President’s framework for business tax reform. Among the key elements were eliminating dozens of tax loopholes and subsidies, broadening the base, and lowering the corporate tax rate to 28 percent to spur growth in America; and simplifying and cutting taxes for America’s small businesses. Although in an election year it is unlikely substantive tax legislation will pass, it is hoped that some bills impacting the hospitality industry will pass.

Regardless of your political leanings, the size of the deficit and the federal debt are of concern. Because of politics, the raising of the debt limit has changed from something done on a regular basis to political chicken, with the realistic potential for a U.S. default during the 2011 discussions.

While we have been in a recession over the last few years, the size of the deficit rivals that from World War II. How will the deficit play out until 2022?

Unfortunately, the Congressional Budget Office analysis is based on the law as it reads today. As such, it projects a rosy scenario with the deficit dropping to 1.5 percent of Gross Domestic Product. However, it is unlikely that all the automatic cuts will be made since so many of them relate to defense spending. Also, it appears unlikely that the Bush tax cuts will be allowed to expire in their entirety. As a result, the alternative scenario could occur, which is unsustainable.

There is no easy solution. Too much of our budget is in entitlements, defense spending, and interest on the debt. Without an increase in revenue, or the political courage to address entitlements, the problem will grow exponentially. The election cycle is continuous. The budget of the President and posturing of Congress are nothing more than election year politics. Both political parties already are geared up for elections so many of the hard decisions will not be made and the buck will be passed to the next Congress or even the next generation.

Kevin Reilly, an attorney and CPA, is a member of the firm of Witt Mares. Witt Mares is a member of PKF International Ltd, an association of legally independent member firms. He heads up the hospitality practice for the Fairfax, Va.-based firm.

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