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Something’s fishy with financial oversight

ALBUQUERQUE, N.M. — In the 2007 movie “Juno,” the lead character, a 16-year-old pregnant girl, is nudged to go home by the woman who will adopt her baby: “Your parents are probably wondering where you are.”

To which Juno replies, “Nah. I’m already pregnant so what other kind of shenanigans can I get into?”

Juno’s reply is akin to the old saying about closing the barn door after the horse has bolted. But the dialogue shows the distinction between the adult and teenage world, as the adult understands that any parent would still care where their daughter was.

I start with this story to show my support for financial regulation, even in a floundering economy, to guard, as best we can, against another debacle of crazed speculation by an all-too-pregnant financial industry playing a game of “heads we win, tails you lose.” The horse did bolt, but we still need to close the barn door.

Even so, there are limits to what oversight we should endure. Our biggest regulatory problem is the failure to distinguish between the too-big-to-fail banks, the multinational corporations and the small-town Dairy Queen.

Admittedly, there are distinctions in regulation by what a business does. But as a tax adviser I too often see anti-abuse rules, designed to cure abuses of taxpayers who have shifted $100 million of income off their books, filter down to companies struggling to earn $100,000 or less of income.

The typical result of these business-regulatory traps is that the dolphins get caught with the tuna. And the dolphins don’t really know what’s happening until they get hauled onto the ship.

And, your point, you say, is? It turns out that New Mexico needs more money to operate. One way to get more money, without those unpopular tax increases, is to chase down the tax cheats and make them pay.

Now I’m all for that. But the trick is identifying the bad guys without making the whole exercise look like the running of the bulls in Pamplona, Spain. Hint: to the bulls, pretty much everyone in sight looks like a bad guy.

Beginning in 2011 New Mexico requires that “pass-through entities,” which include LLCs, partnerships, S corporations, and trusts, remit withholding tax to the state on a quarterly basis.

Individuals must already do this (unless withholdings cover their tax). So the idea is that individuals get income from these pass-through entities, and the entity should pay the state quarterly. The entity should know its income better than the individual.

Now let’s identify the main characters in this play. Nonresidents are the tuna. They may fail to file New Mexico returns and pay tax. Residents are the dolphins. They already file and pay. So how do we build a net to allow the dolphins to escape? And are the dolphins smart enough to find their way out?

Well, the dolphins, the state says, could file a form identifying themselves as dolphins. They will file a Form RPD-41354, signed and notarized, stating that they are a dolphin (stick with me – this is a New Mexico resident). They will give this to the fishing boat operator (pass-through entity).

The fishing boat operator will withhold taxes on quarterly income for all mammals failing to file the Form RPD-41354. This will be done on a Form RPD-41355, with payment remitted on a RPD-41356, and annual statements filed on RPD-41359 and 41367.

Tuna (nonresidents) may agree to pay the tax themselves, by filing a RPD-41353. They will then file the RPD-41355 and 41356. This should now sound like Radar talking to Col. Blake on the old “M*A*S*H” show: “Your initial signifies that instead of signing, you initialed. Then you have to sign this form, which states that you merely initialed the forms that required signing. Then after you’ve signed you put your initial where you signed so that people will know that you OK’d your signature with your initial.”

New Mexico pass-through businesses are small. They rarely compute income quarterly. Some hire advisers once a year to help with tax forms. I don’t mind regulation, but this is one that has to cost more than it will generate to the state. Trust me, it just has to.

James R. Hamill is the director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at jimhamill@rhcocpa.com.

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