Small Business Owners Beware:
Say Goodbye to Tax-Free Internet Sales

Today's comment is by Mark Nestmann, Privacy Expert for The Sovereign Society and President of The Nestmann Group.

Dear A-Letter Reader,

If you can take the IRS at their word, then supposedly the U.S. Treasury loses nearly US$100 billion in unpaid taxes from small businesses.

That's a big number, and I believe it's a gross overstatement. I'll explain why in just a moment. But in reality whatever the number is, the new housing bailout bill is designed to dramatically reduce it.

The IRS believes that America's small businesses are evading billions of dollars in taxes through unreported credit card transactions. And for that reason, it's long been at the top of their legislative agenda to require credit card issuers and electronic payment systems like PayPal to report sales data to the IRS.

Tax Inquisition Planned to
Bailout Deadbeat Homeowners

The housing bailout bill does just that, broken down in terms of payments to businesses accepting the cards. Essentially, the bill requires Visa, MasterCard, Discover, American Express, PayPal, Amazon, Google Checkpoint, and virtually every other "electronic payment system" to track, aggregate, and report to the IRS, information on nearly every electronic transaction.

They must report:

• The gross amount of payment card and third-party network transactions
  
• The name, address, and taxpayer identification number of the participating merchant

However, the bill gives these systems more than two years to gear up for these requirements. Mandatory reporting won't come into effect until 2011.

Basically, what the bill does is to give the IRS a way to check what a credit card company or electronic payment system is actually paying a small business compared to what the business owners are reporting on their tax returns. If the two numbers are wildly out-of-sync, then you're likely to be audited.

eBay Powersellers, Beware!

How might this bill affect you? If you're an eBay Powerseller, for instance, and sell US$40,000 of cosmetics each year over the Internet, at the moment, eBay doesn't have to tell the IRS anything about the sales.

But starting in 2011, eBay will have to send you - and the IRS - an annual report. The report would say for example that Connie's Cosmic Cosmetics received US$40,172.13 in gross payments from eBay for that year.

And here's where it might get very dicey with the IRS. People who operate businesses are supposed to declare their gross income on Schedule C (or a corporate tax return). Then they're supposed to deduct all the costs of doing business to arrive at a net figure of taxable income.

However, a lot of small businesses don't keep particularly good records. All the owners may know are what they have left at the end of the year. And that's what they report as their income, without accounting for their gross income or their expenses. Any Internet business that takes this approach after 2011 will be in for a serious wake-up call!

The Numbers Don't Add Up!

As I mentioned a moment ago, the IRS believes small businesses are evading taxes to the tune of US$100 billion annually. That's the number IRS Commissioner Mark Everson dangled in front of the Senate Budget Committee in 2006.

Everson also said that if Congress unleashed the IRS against small business, it could recover "between US$50 billion and US$100 billion without changing the dynamic between the IRS and the people."

Now, Congress has done exactly that. Only the numbers don't add up. A more recent study from the Treasury Department says that credit card transaction reporting would net less than US$10 billion in added revenue.

And indeed, according to the Congressional Budget Office, the new provisions will raise slightly less. The Budget Office estimated they'll raise a total of US$9.8 billion over a 10-year period.

The Hidden Agenda for Reporting Credit Card Transactions

That's a lot of dough, although it's a pittance for the tax-and-spenders inside the beltway.

For that reason, I don't think matching up credit card transactions with eBay power sellers is the real reason Congress enacted this part of the housing bailout bill. Instead, I think there's a hidden agenda for a much bigger take.

I could be wrong, but it seems to me that setting up an infrastructure that matches credit card transactions with payments to Internet merchants is a tailor-made solution to help collect sales tax.

Right now, most Internet transactions still aren't subject to any form of sales tax. States will be chomping at the bit to get the IRS to share this data with them, so they can directly bill merchants for in-state sales. Any company that does business on the Internet, but doesn't charge sales tax is at risk.

It's not necessarily simple to "know what you owe," either. In addition to the sales tax regimes in effect in nearly all 50 states, online merchants that collect sales tax must negotiate a maze of city, county, and municipal taxes.

Plus, they must file sales tax returns in the jurisdictions in which they sell goods or provide services. Small merchants that can't justify investing thousands of dollars in software that can make the necessary calculations, and file the necessary returns, will be forced out of business.

Then there are the periodic calls for some kind of future national sales tax or value-added-tax. The infrastructure this bill creates will make this tax easy to collect. Everything will be in place, and the IRS can simply send a bill to merchants that don't pay the tax.

Even if this worst-case scenario doesn't come to pass, it's quite clear that if you operate a small business, the IRS has you in its sights. And come 2011, you'd better have the data to track every dollar you spend in business expenses against the gross income reported to the IRS. And if you don't, you can count on a tax inquisition.

MARK NESTMANN,
Privacy Expert & President of The Nestmann Group
www.nestmann.com

P.S. The best thing you can do is speak to a qualified tax professional about these new rules before they come to pass. Also, it's not a bad idea to look to legally avoid taxes on your overall wealth so these new business taxes don't wipe you out. This November, I'll be in Cancun, Mexico with my colleagues to tell you how to do just that - legally of course. This seminar ALWAYS sells out, so beat the rush right now and save up to 21% off the attendance fee. Get all the details here.

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Is the IRS About to Extend Their Reach?

IRS officials just revealed plans to tighten the rules of their so-called "Qualified Intermediary" (QI) program.

Under the QI program, foreign banks have held billions of dollars offshore for American clients without legally having to disclose their names to the IRS.

In exchange, the banks promised to know who their clients are, withhold any taxes due on U.S. securities in their accounts and send that money to the IRS. More than 7,000 foreign banks are enrolled in the program and paid about US$2 billion to the IRS last year.

This all began in 2001. Since then, the IRS has forced foreign banks and financial institutions to become IRS informants, a.k.a. "qualified intermediaries" (QI).

To put it plainly, it's just like how the IRS forced American bankers to spy on their customers with the Bank Secrecy Act and the PATRIOT Act. In the same way, the QI program turned offshore bankers into spies on their U.S. clients, at least in certain defined situations.

Since the IRS imposed the QI rules, U.S. persons holding U.S.-based investments purchased through their offshore banks did have a choice:

1. They could either have offshore banks report the American holdings to the IRS.
2. Or they could have the bank withhold a 30% tax on all interest and dividends paid to them. .

To avoid either event, the U.S. investor could (and we have recommended) not hold any U.S.-based investments through an offshore bank or financial institution. If you don't have U.S. investments, then you're not required to report under the 2001 QI rules.

By comparison, if you held foreign, non-U.S. investments offshore, you would have been exempt both from the QI reporting and the QI tax withholding rules...until now.

Tune in tomorrow, and I'll explain the latest in this rising development.

BOB BAUMAN, Legal Counsel

The Two Places You Can Hide
from These Miserable Markets

Brick walls are everywhere in 2008...

That's how to best describe one of the worst calendar years for global investors since 1974. The MSCI World Index is already down 14% thus far in 2008. And we just overtook 2002 in terms of negative total return.

The last time stock performance was this miserable was during the Nixon and Watergate era. And that's only after barely seven months of trading.

But it's not just global equities getting slammed in 2008. Other relatively conservative investments have been crushed too.

Real estate investment trusts (REITs) are down another 3.5% this year. High-yield bonds and investment-grade corporate bonds are down over 3% and convertible bonds have declined more than 5%. Even super-safe Treasury bonds have risen just 2.3%. In other words, you're barely breaking even once you factor in surging inflation and taxes.

To be sure, commodities and foreign currencies have been the only two asset classes that have logged solid returns during this miserable year for investors. But even here, commodities and many foreign currencies have produced negative total returns since late June as the dollar has stabilized against most currencies.

If that wasn't bad enough, commodities are now correcting heavily after a major rally since last fall. Now commodities sit 13% off their best levels. The mighty euro, up 7% this year against the dollar, has actually declined 5% from its all-time high. And the yen has struggled since March, down more than 9%.

Also, anyone over-weighted in raw materials will tell you July is a painful month for hard assets. For the record, the summer is also typically a bad time of the year for natural resources. That's certainly true now.

As for the benefits of international diversification, forget it. It's a horror story overseas. In 2008, the BRICS have crashed over 16% while the MSCI Emerging Markets Index has tanked more than 15%.

Okay - time for some good news: If you're sitting pretty in cash and T-bills, congratulations!

Cash, despite offering lowly yields under 2% at least protects your nominal principal. But adjusted for inflation, T-bills are paying about 60% less than the official rate of U.S. inflation at 5%. That's a 17-year high. Compared to stocks this year, at least you've got your principal.

At some point, of course, this bear market will end. I suspect that point will arrive when housing bottoms and the credit crisis finally ebbs.

Most market lows historically arrive in the fall and I think this one won't be any different. October or November might offer excellent entry points for investors - IF housing and credit bottoms. Also, a sharply lower oil price would be great for stocks.

We'll have to wait and see. Until then, hang in there. I'll be right here guiding you through this mess with the best long-term solutions to this short-term misery.

ERIC ROSEMAN, Investment Director

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THE SOVEREIGN SOCIETY OFFSHORE A-LETTER
Erika Nolan, Publisher • Mike Burnick, Senior Editor
Kathlyn Von Rohr, Managing Editor • Bob Bauman, Legal Counsel
Eric Roseman, Investment Director • Sean Hyman , Currency Analyst
Autumn Dodson, Email Marketing Manager


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