Archive for the ‘Tax Planning’ Category

On January 1, 2013, the American Taxpayer Relief Act (ATRA) of 2012 was passed by the United States Congress, and was signed into law by President Barack Obama the next day.

Highlights of the Act include but not limited to the following:

Income tax rates. Individual income tax rates will remain at 10%, 15%, 25%, 28%, 33% and 35% with only individuals earning more than $400,000 ($450,000 for joint filers) subjected to the higher rate at 39.6% for income above that threshold.

Capital gain and qualified dividend rates. Taxpayers in the 35% and lower tax bracket continue the 15% rate.  Lower income earners in the 10% and 15% tax brackets will have a 0% rate.  Individuals earning more than $400,000 ($450,000 for joint filers) will pay a 20% tax on capital gains and qualified dividends.  With the new 3.8% Medicare surtax on net investment income, the maximum rate will effectively increase to 23.8% for many higher-income payers.  More on the 3.8% Medicare surtax later in this update.

Itemized deduction (Pease) and personal exemption phase (PEP) outs. The “Pease” (named after Senator Pease) limitation on itemized deductions was reinstated, affecting individuals making $250,000 ($300,000 for joint filers). This provision reduces the total amount of itemized deductions by 3% of the amount that adjusted gross income (AGI) exceeds the threshold amount.  The reduction cannot exceed 80% of the otherwise allowable deductions. Personal exemptions are reduced by 2% for each $2,500 of AGI over the $250,000 for single filers and $300,000 for joint filers.  Exemptions are totally phased out when AGI exceeds $372,500 for single filers and $422,500 for joint filers.

Permanent alternative minimum tax (AMT) relief. ATRA permanently increased the AMT exemption amounts to $51,900 for single filers, $80,750 for joint filers, and $40,375 for married filing separately. The exemption amounts will automatically increase in future years based on the rate of inflation.

Payroll tax holiday ends. The two-year old payroll tax holiday was not extended.  This now returns the employee’s portion of FICA tax to 6.2% from the reduced 4.2%.

Estate and gift tax rates. Estate tax exemptions were increased to $5,250,000 per person and indexed for inflation using 2011 as the base.  Prior to passing ATRA, the exemption amount was set to decrease to $1 million, with the top tax rate increasing to 55%.  By passing the Act, Congress permanently increased the estate tax exemption and unified the exemptions from gift tax and generation-skipping transfer tax (“GST Tax) at the same amount with a top tax rate of 40%. The annual gift tax exclusion increases to $14,000 per donee. Portability of the estate tax exemption between spouses was renewed.

Social Security and Medicare. The wage base increased to $113,700 for 2013 ($110,100 in 2012). Also, benefits increased by 1.7% in 2013.  The basic Medicare Part B premium increased to $104.90 per month.  The Part B and D premiums are higher for upper income individuals if their modified adjusted gross income (MAGI) for 2011 exceeded $170,000 for couples or $85,000 for single individuals.  MAGI is AGI plus tax exempt interest, EE bond interest used for education, and excluded foreign earned income.  The total surcharges on upper income recipients can be as large as $297.40 a month per person.

Additional changes in tax rules for 2013 that were not finalized until January 1, 2013, included the following:

• The personal exemption amount increased to $3,900.

• Health savings account (HSA) deductions increased to $6,450 for family coverage and $3,250 for single coverage.  HSA owners born before 1959 can deduct an additional $1,000.

• Contributions to flexible spending accounts were capped at $2,500.

• The maximum 401(k) contribution increased to $17,500 for 2013.  Individuals born before 1964 can contribute up to $23,000. The limits apply to 403(b) and 457 plans as well.

• 401(k) participants may convert to a Roth 401(k) even if they have not reached the age of 59-1/2.

• The contribution limits for IRAs increase to $5,500. Individuals born before 1964 may contribute an additional $1,000.

The Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 imposed the following new taxes effective for  years beginning on January 1, 2013:

Effective January 1, 2013 is the 3.8% Medicare surtax on net investment income.  It applies to unearned income for single filers and heads of household who have MAGI above $200,000.  For joint filers the tax applies to unearned income if MAGI is over $250,000. Investment income includes interest, dividends, capital gains, annuities, royalties and passive rental income.  Tax free municipal bond interest and retirement plan distributions are not included in the definition of investment income.

Effective January 1, 2013 is a 0.9% Medicare surtax on earned income.  The surtax applies to wages and self-employment income.  It applies to single filers and heads of household when total earnings exceed $200,000 and $250,000 for joint filers. For earnings over the threshold, the effective Medicare tax will be 3.8%, the usual 2.9% tax rate, plus an extra 0.9%.  The surtax only applies to the employee’s share of tax. Employers do not owe it. Employers will withhold the surtax once an employee’s wages exceed the threshold amounts. Employees will then calculate the actual tax due on their Form 1040.

Most people have filed their 2011 Income Tax Returns by now; therefore planning for 2012 should start immediately. Here are eight things the IRS suggests that you should do.

Adjust your withholding. Don’t provide the IRS with an interest free loan. If you had a large overpayment, now is a good time to review your withholding and make adjustments. The reduction in withholding improves your cash flow for the entire year. If you had a substantial underpayment, make adjustments so that interest and penalties are not assessed.

Store your returns and supporting documents in a safe place. If you receive an IRS Notice, or are examined, you will need to access the information quickly. You also need the information to prepare the 2012 income tax returns.

Organize you record keeping. Establish a central location where everyone in your household can place tax-related records all year long.

Review your payroll earnings statement. Make sure the proper withholdings are occurring and that your retirement plan contributions, medical insurance premiums, and flexible spending account contributions are as desired.

Shop for a tax professional early in the year. If you desire to use a professional to plan, strategize, and make financial planning decisions throughout the year, then search now. Choose a professional wisely. You are ultimately responsible for the accuracy of your returns.

Prepare to itemize deductions. If your expenses typically fall just below the amount to make itemizing advantageous, planning to bundle deductions into 2012 may be beneficial.

Strategize tuition payments. The American Opportunity Tax Credit will expire after 2012; therefore it may be advantageous to pay 2013 tuition in 2012.

Keep up with tax law changes. Meet with your tax professional during the year to discuss changes in the law and to discuss changes in your personal circumstances.

This year in particular, year end tax planning is full of uncertainties. This makes it even more difficult than previous years. If you believe that tax rates will not rise in 2011, including the 15% top rate on qualified dividends and long term capital gains, here is what most taxpayers should consider doing:

Accelerate deductions from 2011 to 2010 and defer income into early 2011 (do not jeopardize collection of the income), unless you expect to be at a higher marginal tax rate in 2011.

If you qualify to itemize deductions shift state and local income taxes into 2010. Pay your estimated tax payment s due in January, 2011 in December, 2010. This is not a strategy if you expect to be subject to the dreaded “alternative minimum tax” in 2010. Accelerate charitable contributions into 2010. If possible, make the donations using appreciated investments held more than one year. Do not donate investments that have declined in value. Pay your January, 2011 mortgage payment in December of 2010.

If you plan to do a Roth IRA conversion, converting in 2010 allows you to spread the resulting tax over 2011 and 2012. If you wait until 2011 to convert, the two year spread is not available.

Harvest capital losses, matching losses with capital gains to produce a net loss of $3,000. If you have a capital loss carry forward (from 2009 and earlier years), harvest capital gains if it fits your overall investment strategy in order to take advantage of the tax benefit.

As Certified Public Accountant and CERTIFIED FINANCIAL PLANNER^TM certificants, Karl W. Blovet & Associates has a full range of knowledge, experience and services to offer Chicago area individuals and small businesses in the areas of financial planning, retirement planning, investment planning, tax planning, education planning and accounting.

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Making Work Pay Credit: This provision allows a credit against income tax up to $400 for individuals whose modified adjusted gross income does not exceed $75,000 and $800 for married couples whose modified adjusted gross income does not exceed $150,000. It applies retroactively to January 1, 2009 and will be repeated in 2010. Taxpayers may take this credit through a reduction in payroll withholding or when filing their returns for the year.

$250 Economic Recovery Payment: This provision allows a one-time payment of $250, for 2009 only, to taxpayers on fixed incomes (primarily Social Security recipients).

First Time Home Buyer Tax Credit: The credit is increased to $8,000 for purchases made after December 31, 2008 and before December 1, 2009. It also eliminates any required repayment to the IRS. The credit is phased out for taxpayers with income in excess of $75,000 for individuals and $150,000 for married couples.

New Car Deduction: For the purchase of a new car in 2009, taxpayers are allowed a deduction for state and local sales taxes and excise taxes. Taxpayers do not need to itemize deductions to take advantage of this benefit. The deduction is phased out for individuals with income in excess of $125,000 and married couples with income in excess of $250,000.

Alternative Minimum Tax: This provision raises exemption amounts above the 2008 levels. The patch was designed to insulate approximately 26 million middle-income taxpayers from the AMT in 2009.

Unemployment Compensation: The provision excludes up to $2,400 of unemployment compensation from the recipient’s gross income for 2009.

Transit Benefit: The new law increases the current $120 per month income exclusion amount for transit passes to $230 per month.

COBRA Benefits: The provision allows individuals who are involuntarily separated from employment between September 1, 2008 and January 1, 2010 to elect to pay 35% of his/her COBRA coverage and have it treated as paying 100%.

If you are creating a new business or unhappy with your current business structure, you need to consider the appropriate business entity. Whether to incorporate or form a limited liability company (LLC) is not always obvious. Under the Internal Revenue Code (IRC), a corporation is either a “C Corp” or an “S Corp.” An LLC is either a sole proprietorship (single member), a partnership (two or more members), a “C Corp,” or an “S Corp (if it meets all of the requirements and files a timely election).”

Tax issues to consider when choosing an entity: Sale of the business/liquidation. Tax rate exposure. Utilization of losses by the shareholders/members. Compensation/fringe benefit packages. Payroll tax liabilities and associated complexities. And state taxes.

Non-tax issues to consider: Limited liability protection for shareholders/members. The capital structure of the entity. Buy-sell agreements. The type of business/investment activity. And the applicable state law and other corporate legal formalities.

As indicated, there are many reasons to choose one structure over another. With that in mind, here is a brief description of these business entities

Sole Proprietorship

The simplest and least expensive structure. Works best if you are on your own, in a low risk business. No double taxation on profits, such as under a “C Corp.” Profits/losses reflected on Form Schedule C of the Form 1040. Unlimited liability for the owner and all income subject to the onerous “self-employment” tax.

Partnership

An unincorporated business that has two or more partners. There are two types: general and limited. In a general, partners share in management and are each 100% responsible for the partnership obligations. In a limited, there are general and limited partners. The general partners manage the business and are personally liable for obligations. The limited partners cannot participate in management, but share in the profits. Their liability is limited to the amount of their capital contributions. Profits are taxed only once, at the partners’ marginal tax rate.

C Corporation

They are taxed (federal and state) at the entity level and are subject to taxes on income generated by the business. Shareholders pay taxes (double taxation) on the profits distributed (dividends) to them. Liability is limited to the shareholder’s investment. They have an unlimited life and possess ease of transferability of ownership. Employment taxes can be minimized. Although, a reasonable salary must be paid.

S Corporation

Corporations with fewer than 100 shareholders can elect to be taxed under Subchapter S of the IRC. With some exceptions, the “S Corp” is not subject to federal tax at the entity level. Profits and losses flow through to the shareholders, to be reported on their tax returns at their marginal tax rates. Some states tax “S Corps” at the entity level. Employment taxes can be minimized for owners receiving a salary. Although, the amount of the salary must be reasonable compared to the profits being generated by the entity.