Year-end tax planning is always complicated by the uncertainty that the following year may bring and 2012 is no exception.  This Tax Briefing covers year-end tax planning considerations that are especially unique to 2012.

 2012 YEAR-END TAX PLANNING FOR BUSINESSES

In recent years, end-of-the-year tax planning for businesses has been complicated by uncertainty over the future availability of many tax incentives. This year is no different.  In 2010, Congress extended many business tax incentives for one or two years. Now, those incentives have expired or are scheduled to expire. Whether they will be extended beyond 2012 is unclear as Congress debates with the fate of the fate of the Bush-era tax cuts and across-the-board spending cuts scheduled to take effect in 2013. In the meantime, you need to be aware of the expiring provisions and explore developing a multiyear tax strategy that takes into account various scenarios for the future of these incentives.

Code Sec. 179 expensing.  Code Sec. 179 gives businesses the option of claiming a deduction for the cost of qualified property all in its first year of use rather than claiming depreciation over a period of years. For 2010 and 2011, the Code Sec. 179 dollar limitation was $500,000 with a $2 million investment ceiling. For 2012, the amounts are less generous. The dollar limitation for 2012 is $139,000 with a $560,000 investment ceiling. Under current law, the Code Sec. 179 dollar limit is scheduled to drop to $25,000 for 2013 with a $200,000 investment ceiling.

Businesses should consider accelerating purchases into 2012 to take advantage of the still generous Code Sec. 179 expensing. Qualified property must be tangible personal property, which you actively use in your business, and for which a depreciation deduction would be allowed. Qualified property must be newly purchased new or used property, rather than property you previously owned but recently converted to business use. Examples of types of property that would qualify for Code Sec. 179 expensing are office equipment or equipment used in the manufacturing process. Additionally, Code Sec. 179 expensing is allowed for off-the-shelf computer software placed in service in tax years beginning before 2013.

If your equipment purchases for the year exceed the expensing dollar limit, you can decide to split your expensing election among the new assets any way you choose. If you have a choice, it may be more valuable to expense assets with the longest depreciation periods. As long as you start using your newly purchased business equipment before the end of the tax year, you get the entire expensing deduction for that year. The amount that can be expensed depends upon the date the qualified property is placed in service; not when the qualified property is purchased or paid for. 

Congress could raise the Code Sec. 179 dollar limit and investment ceiling for 2013. In July 2012, the Senate voted to increase the Code Sec. 179 dollar amount to $250,000 with an $800,000 investment limitation for tax years beginning after December 31, 2012. The House voted to increase the Code Sec. 179 dollar amount to $100,000 with a $400,000 investment limitation for tax years beginning after December 31, 2012. 

Bonus depreciation.  The 50 percent bonus first-year depreciation deduction is scheduled to expire after 2012 (2013 in the case of certain longer-production period property and certain transportation property). Unlike the Section 179 expense deduction, the bonus depreciation deduction is not limited to smaller companies or capped at a certain dollar level. To be eligible for bonus depreciation, qualified property must be depreciable under Modified Accelerated Cost Recovery System (MACRS) and have a recovery period of 20 years or less. The property must be new and placed in service before January 1, 2013 (January 1, 2014 for certain longer-production period property and certain transportation property). 

Businesses also need to keep in mind the relationship of bonus depreciation and the vehicle depreciation dollar limits.  Code Sec. 280F(a) imposes dollar limitations on the depreciation deduction for the year a taxpayer places a passenger automobile in service within a business, and for each succeeding year. Code Sec. 168(k)(2)(F)(i) increases the first-year depreciation allowed for vehicles subject to the Code Sec. 280F luxury-vehicle limits, unless the taxpayer elects out, by $8,000, to which the additional first-year depreciation deduction applies.  The maximum depreciation limits under Code Sec. 280F for passenger automobiles first placed in service by the taxpayer during the 2012 calendar year are: $11,160 for the first tax year ($3,160 if bonus depreciation is not taken); $5,100 for the second tax year; $3,050 for the third tax year; and $1,875 for each tax year thereafter. The maximum depreciation limits under Code Sec. 280F for trucks and vans first placed in service during the 2012 calendar year are $11,360 for the first tax year ($3,360 if bonus depreciation is not taken); $5,300 for the second tax year; $3,150 for the third tax year; and $1,875 for each tax year thereafter. Sport utility vehicles and pickup trucks with a gross vehicle weight rating in excess of 6,000 pounds are exempt from the luxury vehicle depreciation caps. 

New de minimis rule in repair regulations.  Comprehensive repair and capitalization regulations issued by the IRS in late 2011 open up a new planning opportunity. A new de minimis expensing rule allows a taxpayer to deduct certain amounts paid or incurred to acquire or produce a unit of tangible property if the taxpayer has an Applicable Financial Statement (AFS), written accounting procedures for expensing amounts paid or incurred for such property under certain dollar amounts, and treats the amounts as expenses on its AFS in accordance with its written accounting procedures. An overall ceiling limits the total expenses that a taxpayer may deduct under the de minimis rule. The de minimis expensing rule applies to amounts paid or incurred (to acquire or produce property) in tax years beginning on or after January 1, 2012. 

Let’s look at an example. A taxpayer purchases 10 VoIP phones for its business at $200 each for a total cost of $2,000. Each phone is a unit of property and is not a material or supply. The taxpayer has an applicable financial statement and a written policy at the beginning of the tax year to expense amounts paid for property costing less than $500. The taxpayer treats the amounts paid for the phones as an expense on its applicable financial statement. Assume further that the total aggregate amount treated as de minimis and not capitalized, including the amounts paid for the phones, are less than or equal to the greater of 0.1 percent of total gross receipts or 2 percent of the taxpayer’s  total financial statement depreciation. The result: the de minimis rule applies and the taxpayer is not required to capitalize any portion of the $2,000 paid for the 10 phones. 

Dividends.  Under current law, tax-favorable dividends tax rates are scheduled to expire after 2012. Qualified dividends are eligible for a maximum 20 percent tax rate for taxpayers in the 25 percent and higher brackets; zero percent for taxpayers in the 10 and 15 percent brackets. In July, the House voted to extend the current dividend tax treatment through 2013. The Senate, however, voted to extend the tax favorable rates only for individuals with incomes below $200,000 (families with incomes below $250,000). For income in excess of $200,000/$250,000 the tax rate on capital gains and dividends would be 20 percent.

If Congress taxes no action, qualified dividends will taxed at the ordinary income tax rates after 2012 (with the highest rate scheduled to be 39.6 percent not taking into account the 3.8 percent Medicare contribution tax for higher income individuals). Qualified corporations may want to explore declaring a special dividend to shareholders before January 1, 2013. 

Expired business tax incentives.  Many temporary business tax incentives expired at the end of 2011. In past years, Congress has routinely extended these incentives, often retroactively, but this year may be different. Confronted with the federal budget deficit and across-the-board spending cuts scheduled to take effect in 2013, lawmakers allow some of the business tax extenders to expire permanently. Certain extenders, however, have bipartisan support, and are likely to be extended.  They include the Code Sec. 41 research tax credit, the Work Opportunity Tax Credit (WOTC), and 15-year recovery period for leasehold, restaurant and retail improvement property. 

Small employer health insurance credit.  A potentially valuable tax incentive has often been overlooked by small businesses, according to reports. Employers with 10 or fewer full-time employees (FTEs) paying average annual wages of not more than $25,000 may be eligible for a maximum tax credit of 35 percent on premiums paid for tax years beginning in 2010 through 2013. Tax-exempt employers may be eligible for a maximum tax credit of 25 percent for tax years beginning in 2010 through 2013. 

The Code Sec. 45R credit is subject to phase-out rules. The credit is reduced by 6.667 percent for each FTE in excess of 10 employees. The credit is also reduced by four percent for each $1,000 that average annual compensation paid to the employees exceeds $25,000. This means that the credit completely phases out if an employer has 25 or more FTEs and pays $50,000 or more in average annual wages. 

Let’s look at an example. A for-profit employer has 10 FTEs and pays average annual wages of $250,000 in tax year 2012. The employer’s qualified employee health care costs for tax year 2012 are $70,000. The employer’s Code Sec. 45R credit is $24,500 ($70,000 x 35 percent). 

The credit is scheduled to climb to 50 percent of qualified premium costs paid by for-profit employers (35 percent for tax-exempt employers) for tax years beginning in 2014 and 2015. However, an employer may claim the tax credit after 2013 only if it offers one or more qualified health plans through a state insurance exchange. 

Year-end tax planning is always complicated by the uncertainty that the following year may bring and 2012 is no exception.  This Tax Briefing covers year-end tax planning considerations that are especially unique to 2012.

  2012 YEAR-END TAX PLANNING FOR INDIVIDUALS

2012 began with great uncertainty over federal tax policy and now, with the end of the year approaching, that uncertainty appears to be far from any long-term resolution. A host of reduced tax rates, credits, deductions, and other incentives (collectively called the "Bush-era" tax cuts) are scheduled to expire after December 31, 2012. To further complicate planning, over 50 tax extenders are up for renewal, either having expired at the end of 2011 or scheduled to expire after 2012. At the same time, the federal government will be under sequestration, which imposes across-the-board spending cuts after 2012. The combination of all these events has many referring to 2013 as "taxmeggedon."

Expiring incentives. Effective January 1, 2013, the individual income tax rates, without further Congressional action, are scheduled to increase across-the-board, with the highest rate jumping from 35 percent to 39.6 percent. The current 10 percent rate will expire and marriage penalty relief will sunset. Additionally, the current tax-favorable capital gains and dividends tax rates (15 percent for taxpayers in the 25 percent bracket rate and above and zero percent for all other taxpayers) are scheduled to expire. Higher income taxpayers will also be subject to revived limitations on itemized deductions and their personal exemptions. The child tax credit, one of the most popular incentives in the Tax Code, will be cut in half. Millions of taxpayers would be liable for the alternative minimum tax (AMT) because of expiration of the AMT “ "patch." Countless other incentives for individuals would either disappear or be substantially reduced after 2012. While a divided Congress may indeed act to prevent some or all of these tax increases, a year-end planning strategy that protects against "worst-case" situations may be especially wise to consider this year.

Year-end planning & Income tax withholding. Expiration of the reduced individual tax rates will have an immediate impact. Income tax withholding on payrolls will immediately reflect the increased rates. One strategy to avoid being surprised in 2013 is to adjust your income tax withholding. Keep in mind that the current two percent payroll tax holiday is also scheduled to expire after 2012 so it is a good time to review if you are having too much or too little federal income tax withheld from your pay.

As mentioned, traditional year-end planning techniques should be considered along with some variations on those strategies. Instead of shifting income into a future year, taxpayers may want to recognize income in 2012, when lower tax rates are available, rather than shift income to 2013. Another valuable year-end strategy is to "run the numbers" for regular tax liability and AMT liability. Taxpayers may want to explore if certain deductions should be more evenly divided between 2012 and 2013, and which deductions may qualify, or will not be as valuable, for AMT purposes.

Harvesting losses. Now is also a good time to consider tax loss harvesting strategies to offset current gains or to accumulate losses to offset future gains (which may be taxed at a higher rate). The first consideration is to identify whether an investment qualifies for either a short-term or long-term capital gains status, because you must first balance short-term gains with short-term losses and long-term ones with long-term losses. Remember also that the "wash sale rule" generally prohibits you from claiming a tax-deductible loss on a security if you repurchase the same or a substantially identical asset within 30 days of the sale.

Education expenses. Taxpayers with higher educational expenses may want to consider the scheduled expiration of the American Opportunity Tax Credit (AOTC) after 2012 in their plans. The AOTC (an enhanced version of the HOPE education credit) reaches the sum of 100 percent of the first $2,000 of qualified expenses and 25 percent of the next $2,000 of qualified expenses, subject to income limits. If possible, pre-paying 2013 educational expenses before year-end 2012 could make the expenses eligible for the AOTC before it expires. Another popular education tax incentive, the Lifetime Learning Credit, is not scheduled to expire after 2012.

Job search expenses. Some expenses related to a job search may be tax deductible. There is one important limitation: the expenses must be spent on a job search in your current occupation. You may not deduct expenses you incur while looking for a job in a new occupation. Examples of job search expenses are unreimbursed employment and outplacement agency fees you pay while looking for a job in your present occupation. Travel expenses to look for a new job may be deductible. The amount of job search expenses that you can claim on your tax return is limited. You can claim the amount of expenses only to the extent that they, together with other "miscellaneous" deductions exceed two percent of your adjusted gross income.

Gifts. Gift-giving as a year-end tax strategy should not be overlooked. The annual gift tax exclusion per recipient for which no gift tax is due is $13,000 for 2012. Married couples may make combined tax-free gifts of $26,000 to each recipient. Use of the lifetime gift tax exclusion amount ($5.12 million for 2012) should also be considered. Without Congressional action, the exclusion amount drops to $1 million in 2013.

Charitable giving. For many individuals, charitable giving is also a part of their year-end tax strategy. Under current law, the so-called "Pease limitation" (named for the member of Congress who sponsored the law) is scheduled to be revived after 2012. The Pease limitation generally requires higher income individuals to reduce their tax deductions by certain amounts, including their charitable deduction. A special rule for contributing IRA assets to a charity by individuals age 70 ½ and older expired after 2011 but could be renewed for 2012.

New Medicare taxes. In 2013, two new taxes kick-in. The Patient Protection and Affordable Care Act (PPACA) imposes an additional 0.9 percent Medicare tax on wages and self-employment income and a 3.8 percent Medicare contribution tax. The 3.8 percent Medicare contribution tax will apply after 2012 to single individuals with a modified adjusted gross income (MAGI) in excess of $200,000 and married taxpayers with an MAGI in excess of $250,000. MAGI for purposes of the Medicare contribution tax includes wages, salaries, tips, and other compensation, dividend and interest income, business and farm income, realized capital gains, and income from a variety of other passive activities and certain foreign earned income. For individuals liable for the tax, the amount of tax owed will be equal to 3.8 percent multiplied by the lesser of (1) net investment income or (2) the amount by which their MAGI exceeds the $200,000/$250,000 thresholds. Taxpayers with MAGIs below the $200,000/$250,000 thresholds will not be subject to the 3.8 percent tax.

More changes for 2013. Many employers with health flexible spending arrangements (health FSAs) limit salary reduction contributions to between $2,500 and $5,000. Effective 2013, the PPACA requires health FSAs under a cafeteria plan to limit contributions through salary reductions to $2,500. After 2013, the $2,500 limitation is scheduled to be adjusted for inflation. Individuals with unused health FSA dollars should consider spending them before year-end, or a 2 ½ month grace period if applicable, to avoid the "use it or lose it" rule. Keep in mind that health FSA dollars cannot be used for over-the-counter medications (except for insulin) after 2011.

Additionally, the threshold to claim an itemized deduction for unreimbursed medical expenses increases from 7.5 percent of adjusted gross income (AGI) to 10 percent of AGI after 2012. The PPACA provides a temporary exception for individuals (or their spouses) who are age 65 and older. This exception ends after 2017. While many medical expenses cannot be timed for tax-deduction purposes, batching expenses into 2012, when the threshold is 7.5 percent, may make it more likely that the expenses will exceed that threshold.

Looking ahead. In July 2012, the House and Senate passed competing bills to extend many of the expiring incentives one more year. Both bills would extend the current income tax rates (10, 15, 25, 28, 33, and 35 percent) through 2013. The House bill would extend the current capital gains and dividends treatment but the Senate bill would extend the tax favorable rates only for individuals with incomes below $200,000 (families with incomes below $250,000). For income in excess of $200,000/$250,000 the tax rate on capital gains and dividends would be 20 percent. Both bills would extend the $1,000 child tax credit through 2013 and provide for an AMT patch for 2012 (the House bill also provides an AMT patch for 2013).

At this time, it is increasingly likely that the fate of all the expiring tax provisions will be decided by the lame-duck Congress after the November elections. Although the House and Senate bills passed in July differ, they have many points in common; the most important being that lawmakers could agree on a one-year extension of the Bush-era tax cuts. However, some observers anticipate no resolution until January 2013 or beyond.

Today’s uncertainty makes doing nothing or adopting a wait and see attitude very tempting. Multi-year tax planning, which takes into account a variety of possible scenarios and outcomes, however, can provide a win-win combination irrespective of what happens. Please contact our office for more details on how we can customize a tax strategy for you in uncertain times.

President Obama recently said that he wants a tax reform/deficit reduction package by August and lawmakers have many proposals to consider. The President has introduced a $3.77 trillion budget for fiscal year (FY) 2014 with a host of tax reform proposals, the House and Senate Budget Committees have approved competing deficit reduction and tax reform blueprints, other committees are exploring ideas for tax reform, and private groups, most notably authors of the Simpson-Bowles Plan, are also making proposals. Whatever proposals are adopted, the outcome is sure to impact your tax strategy and planning.

President Obama recently said that he wants a tax reform/deficit reduction package by August and lawmakers have many proposals to consider. The President has introduced a $3.77 trillion budget for fiscal year (FY) 2014 with a host of tax reform proposals, the House and Senate Budget Committees have approved competing deficit reduction and tax reform blueprints, other committees are exploring ideas for tax reform, and private groups, most notably authors of the Simpson-Bowles Plan, are also making proposals. Whatever proposals are adopted, the outcome is sure to impact your tax strategy and planning.

All of the proposals have one common goal: reduce the federal government's approximate $16 trillion federal budget deficit. To reduce the budget deficit, many of the plans propose to cut spending and raise revenues. Lawmakers and the White House also want to replace sequestration (across-the-board spending cuts for many federal agencies) for FY 2014 and beyond. Replacing sequestration will require spending cuts, new revenue or a combination of both. Let's take a look at how some of the tax proposals would affect individuals, businesses and others.

Individuals

The American Taxpayer Relief Act of 2012 (ATRA), signed into law on January 2, 2013, set the individual tax rates at 10, 15, 25, 28, 33, 35 and 39.6 percent for 2013 and beyond. The House GOP budget blueprint would consolidate the current seven individual income tax rate brackets into two rates. The lower rate would be 10 percent with the goal of a top rate of 25 percent. The Simpson-Bowles plan also calls for lower rates but does not specify the amounts; however, lower rates would be contingent on eliminating certain tax credits and deductions, possibly some popular ones such as the home mortgage interest deduction. President Obama has not proposed any changes to the current individual income tax rates.

President Obama has, however, proposed a minimum 30 percent tax on individuals with incomes over $1 million (full phase in at $2 million).  This was known as the "Buffett Rule" (now called the Fair Share Tax).  President Obama would also limit the tax rate at which higher income individuals can reduce their tax liability to a maximum of 28 percent. This limit would apply to all itemized deductions; foreign excluded income; tax-exempt interest; employer sponsored health insurance; retirement contributions; and selected above-the-line deductions. Another proposal would limit contributions and accruals on tax-favored retirement accounts, including IRAs, qualified plans, tax-sheltered annuities, and deferred compensation plans.

The budget blueprint put forward by Senate Democrats makes similar proposals. The Senate plan would impose across-the-board limits on itemized deductions claimed by the top two percent of income earners, by capping the rate at which itemized deductions and other tax preferences reduce tax liability, a percentage of income cap, or a specific dollar cap.  The Senate plan also proposes to change, without giving details, unspecified itemized deductions into tax credits.

Not surprisingly, the House plan, written by the GOP, does not include these proposals.  Along with consolidating the individual tax rates, the House blueprint would repeal the 3.8 percent net investment income (NII) surtax and the 0.9 percent Additional Medicare Tax, both of which took effect in 2013. The House plan also calls for repealing the alternative minimum tax (AMT). The House plan also calls for tax simplification but does not give details.

Another proposal endorsed by the President but which will be a difficult sale in Congress is to increase the federal estate tax. ATRA "permanently" extended the estate tax at a maximum rate of 35 percent with a $5 million exclusion (indexed for inflation).  President Obama wants to raise the maximum rate to 45 percent with a $3.5 million exclusion (not indexed for inflation) after 2017. 

Businesses

Reducing the U.S. corporate tax rate is a common goal of many of the tax reform proposals but they take different approaches. President Obama has said he would support lowering the corporate tax rate in exchange for businesses giving up unspecified tax preferences. These could include tax incentives for fossil fuels, the Code Sec. 199 deduction and more. The House blueprint would reduce the top corporate tax rate to 25 percent, paid for by tax savings elsewhere. The Simpson-Bowles plan also calls for a reduction in the corporate tax rate, contingent on businesses relinquishing unspecific tax preferences.

President Obama and the House and Senate budgets also propose a number of incentives to encourage business spending and job creation. These include:

• Enhanced small business expensing (Obama and House but at different amounts);
• Permanent research tax credit (Obama, House and Senate);
• Temporary tax credit for increasing payrolls (Obama); and
• Special incentives for manufacturing in the U.S. (Obama).

Another key difference among the competing proposals: the House budget plan would repeal the Patient Protection and Affordable Care Act, including all of its business tax-related provisions, such as employer-shared responsibility provisions, the medical device excise tax, and more.  The Senate approved a non-binding resolution to repeal the medical device tax but is not expected to go along with repeal of the entire Affordable Care Act.

Internet sales tax

In May, the Senate is expected to approve the Marketplace Fairness Act (H.R. 743). The bill gives states the authority to compel online merchants, no matter where they are located, to collect sales tax at the time of a transaction.  However, states would be able to compel collection of sales tax only after they have simplified their sales tax laws, such as by adopting the Streamlined Sales and Use Tax Agreement.  The bill has the support of President Obama. However, the bill may not pass in the House, where many lawmakers view it as a tax increase.

Discussion drafts

The two Congressional tax writing committees – House Ways and Means and Senate Finance – are engaged in discussions among their members over tax reform.  Ways and Means has produced three detailed discussion drafts exploring possible approaches to reforming the taxation of financial products, the taxation of small businesses and moving the U.S. to a territorial system of taxation. Ways and Means Chair Dave Camp, R-Mich., has promised to introduce tax reform legislation this year. Senate Finance has also produced four discussion drafts, less detailed than the House drafts, on simplifying the Tax Code, business taxation and education, and infrastructure, energy and natural resources. Senate Finance Committee Chair Max Baucus, D-Mont., has pledged his commitment to seeing tax reform through before his retirement, which he announced would start at the end of 2014.

Looking ahead

Tax reform coupled with deficit reduction is starting to gain momentum. Whether this will lead to legislation this summer or before year-end is unclear. As long as the key players continue their discussions, there is the chance of tax reform.

Our office will keep you posted of developments. Please contact our office if you have any questions about the tax reform proposals we have reviewed.

Did you owe tax on your 2012 tax return? Did you receive a sizeable refund? Or, conversely, did you receive a smaller refund than you expected? If so, take another look at your tax return from this past year. It is quite possible that by making a few changes, you could put more money in your pocket in the short term. And by examining your investments as they are reported on your tax return, you may be able to strategize for the long-term future. Trying to implement this type of plan may seem difficult at first. However, just by looking at your tax return, you can start the critical planning that can lead you to broader goals of financial independence and a comfortable retirement.

Did you owe tax on your 2012 tax return? Did you receive a sizeable refund? Or, conversely, did you receive a smaller refund than you expected? If so, take another look at your tax return from this past year. It is quite possible that by making a few changes, you could put more money in your pocket in the short term. And by examining your investments as they are reported on your tax return, you may be able to strategize for the long-term future. Trying to implement this type of plan may seem difficult at first. However, just by looking at your tax return, you can start the critical planning that can lead you to broader goals of financial independence and a comfortable retirement.

Federal withholding

If you received a large tax refund, it might be time for you to adjust the amount of tax the federal government withholds from your paycheck. Although next year your refund check may not be as large, you will have the advantage of seeing a larger sum deposited directly into your pocket every month. To adjust your withholding, fill out and sign a Form W-4, and submit it to your employer. You would want to do this in cases where your adjustments to income, exemptions, and deductions remain relatively steady from year-to-year, and where the government consistently is required to give you a large refund.

If you do not change your withholding allowances, the government essentially is holding your money for a year without paying any interest on it. You may lose some potential investment opportunity or, at the very least, the ability to increase your monthly discretionary income. On the other hand, many taxpayers prefer to receive the large refund check after tax filing season because it is a no-hassle way to ensure large savings at the end of the year.

Conversely, many taxpayers may want to change their withholding allowances because they owe the government a significant amount of money at the end of the year. Taxpayers who expect to owe at least $1,000 in tax for the 2013 tax year, after subtracting withholding and any refundable credits, and who also expect their 2013 withholding and credits to be significantly less than the projected tax owed for 2013, may need to file estimated taxes. Failure to do so could result in penalties. Alternatively, taxpayers should consider making quarterly estimated tax payments, especially if they anticipate a significant amount of investment gains for the year or other income unrelated to wage compensation.

State withholding

Some people are entirely exempt from state tax, but it is withheld from their paychecks nevertheless. At the end of each year, they may include the amount of their state taxes in their itemized deductions, but then receive a refund which they have to declare as income in the next year. This problem particularly applies to active duty military families, many of whom are posted in states other than their state of residency. Military families can check with their state income tax authority to see if there is an appropriate form that can be completed and filed, which would exempt them from withholding. A higher adjusted gross income (AGI), even if it is subsequently reduced by itemized deductions, can erode other adjustments to income, such as a deduction for student loans, IRA contributions, higher education expenses, and more because of certain AGI caps on these benefits.

Tax rates and adjusted gross income

As you may have heard, Congress allowed the Bush-era tax cuts to expire for higher-income earners. That means joint filers with more than $450,000 of adjusted gross income ($400,000 for single individuals) are now in the 39.6-percent tax bracket. Taxpayers at this level of income or above are also subject to a higher long-term capital gains tax rate: 20 percent, up from 15 percent paid by other taxpayers.

In addition, for tax years beginning in 2013, the 33-percent tax bracket for individual taxpayers ends at $398,350 for married individuals filing joint returns, heads of households, and single individuals. If you were hovering near the bottom of the 35-percent bracket for the 2012 tax year, then you might want to see if you can readjust your income so that you fall within the 33-percent category.

Higher-income taxpayers also have two new taxes to worry about for 2013 and beyond. Joint-filing taxpayers with modified adjusted gross income of $250,000 ($200,000 for single filers) are also subject to the 3.8-percent surtax on net investment income and a .9-percent Additional Medicare Tax. Look at your adjusted gross income for last year. Does it approach these figures? Is it on the edge of the income brackets? Will stock market increases this year put you over the top of those income thresholds? If so, it may be time to find ways to reduce your income for 2013.

Investments

At some point in your efforts over the years to accumulate a savings nest egg, you will need to consider diversification, the process of putting your money in the right kind of investment vehicles to satisfy your personal risk strategy and achieve your goals. Looking at your tax return will help you decide whether the investments you now have are the right ones for you. For example, if you are in a high tax bracket and need to diversify away from common stocks, investing in tax-exempt bonds might help, especially if you have state income taxes to worry about, too.

Reviewing the Schedule D and Form 8949, which cover Capital Gains and Losses from last year's return and from the past three or four years, can be an eye-opener for many. Did you hold stocks long enough to be entitled to the long-term capital gains rate? Did you try to balance short-term gains with short-term losses? Are you bouncing from one investment trend to another without a long-term investment plan that achieves long-term needs? Are your mutual funds "tax smart"? Become familiar with different types of banking institutions and their products. Find out about CDs, money-market funds, government securities, mutual funds, index funds, and sector funds and how they interrelate with the determination of your tax liability each year. You may want to put that knowledge to work in your investment strategy.

Medical costs

Should you be taking advantage of the medical expense deduction? Many people assume that with the 10 percent adjusted gross income floor on medical expenses now imposed for tax years starting in 2013 (7.5 percent for seniors) that it doesn't pay for them to keep track of expenses to test whether they are entitled to itemize. But with the premiums for certain long-term care insurance contracts now counted as a medical expense, some individuals are discovering that along with other health insurance premiums, deductibles and timing of elective treatments, the medical tax deduction may be theirs for the taking.

Retirement planning

Don't forget to protect for eventualities. Are you maximizing the amount that Uncle Sam allows you to save tax-free for retirement? A look at your W-2 for the year, and at the retirement contribution deductions allowed in determining adjusted gross income should tell you a lot. Should your spouse set up his or her own retirement fund, too? Are you over-invested in tax-deferred retirement plans? If so, you may lose a significant amount of your nest egg to tax after retirement.  

When you are reviewing last year's tax return, it may help to review some of what you've learned from it. This could foster an important conversation with your tax advisor about how to establish or modify your plan for your financial future. If you would like to review last year's completed tax return with future planning in mind, please feel free to give us a call and set up a time when we can meet and discuss this matter.

Questions over the operation of the new 3.8 percent Medicare tax on net investment income (the NII Tax) continue to be placed on the IRS's doorstep as it tries to better explain the operation of the new tax.  Proposed "reliance regulations" issued at the end in 2012 (NPRM REG-130507-11) "are insufficient in many respects," tax experts complain, as the IRS struggles to turn its earlier guidance into final rules.

Questions over the operation of the new 3.8 percent Medicare tax on net investment income (the NII Tax) continue to be placed on the IRS's doorstep as it tries to better explain the operation of the new tax.  Proposed "reliance regulations" issued at the end in 2012 (NPRM REG-130507-11) "are insufficient in many respects," tax experts complain, as the IRS struggles to turn its earlier guidance into final rules.

A public hearing on the existing regulations, held at IRS headquarters in Washington, D.C., in early April 2013, only confirmed how the application of the NII Tax to certain categories of income—particularly income arising from "passive activities"—is challenging even the experts. Nevertheless, taxpayers are not getting a reprieve from the immediate application of this new tax.  The 3.8 percent Medicare surtax on net investment income (NII) became effective January 1, 2013. Current confusion over exactly how the 3.8 percent operates can impact on tax strategies that should be put into motion in 2013. Any misinterpretation can also bear on 2013 estimated tax that may be due to cover any 3.8 percent NII Tax liability.

NII Tax Thresholds

For tax years beginning after December 31, 2012, the NII surtax on individuals equals 3.8 percent of the lesser of: net investment income for the tax year, or the excess, if any, of:

• the individual's modified adjusted gross income (MAGI) for the tax year, over
• the threshold amount.

The threshold amount in turn is equal to:

• $250,000 in the case of a taxpayer making a joint return or a surviving spouse,
• $125,000 in the case of a married taxpayer filing a separate return, and
• $200,000 in any other case.

Trusts and estates are also subject to the NII surtax, to the extent of the lesser of: (i) undistributed net investment income, or (ii) the excess of adjusted gross income over the dollar amount at which the highest tax bracket begins (which, for 2013, is $11,950).

Net Investment Income

The primary confusion over application of the 3.8 percent NII Tax revolves around finding a precise definition of "net investment income" as enacted by Congress. To appreciate the complexity of the task, just look at the applicable Internal Revenue Code provision. Code Sec. 1411(c)(1) defines net investment income as the sum of:

• Category (i) income: Gross income from interest, dividends, annuities, royalties, and rents, other than such income which is derived in the ordinary course of a trade or business not described in Code Sec. 1411(c)(2);
• Category (ii) income: Other gross income derived from a trade or business described in Code Sec. 1411(c)(2); and
• Category (iii) income: Net gain attributable to the disposition of property, other than property held in a trade or business not described in Code Sec. 1411(c)(2); over

Deductions properly allocable to such gross income or net gain.

A Code Sec. 1411(c)(2) trade or business includes a passive activity under Code Sec. 469 with respect to the taxpayer or trading in financial instruments or commodities.

Comment.  Code Sec 1411 effectively creates a new tax and a new tax base, on top of the income tax, alternative minimum tax, self-employment tax and payroll taxes. Nevertheless the Preamble to the proposed regs states that, except as otherwise provided, the income tax rules should apply to Code Sec. 1411 unless good cause otherwise exists. Practitioners have asked the IRS that the final regulations give greater reassurance of this general rule.

Complexity

The IRS has stated that the principal purpose of Code Sec. 1411 is "to impose a tax on unearned income or investments of certain individuals, estates, and trusts." Unfortunately, Code Sec. 1411 is not so direct and simple, with its three categories of income (that is, (i), (ii) and (iii), above), complicating matters, albeit in an effort to close every door to those who try to "game the system."

Application of the 3.8 percent NII Tax to capital gains and dividends from a personal stock portfolio is clear under this rule of thumb. But clarity breaks down when a "trade or business" is thrown into the mix and the concept of "passive activity" is added to it.

If gain or other income is the result of an active business activity, it generally escapes NII Tax. However, when the "active" business is a passive activity (for example, a rental business), it may be deemed to generate income that is subject to the NII Tax. Furthermore, when a passive activity is not merely incidental to a business however otherwise active that business should be, the NII Tax also becomes an issue. 

Passive Activity

Any revised or additional rules from the IRS on the application of the NII Tax on passive activities should be made more user friendly to the broad middle range of taxpayers and their advisors, one expert at the hearing recommended.  The IRS should err on the side of explaining things clearly and simply, even at the expense of not covering every possible nuance of interpretation.

At the same time, however, other experts are asking for more detail, at least in the way of clarification. For example, the IRS has stated that passive activity for NII Tax purposes should be applied within a narrower scope than the passive activity loss rules under Code 469.  Those Code Sec. 469 rules restrict "passive losses" from reducing income that is not "passive income."  Experts want the IRS to explain exactly what they mean by a "narrower scope."

Self-Rental Activities/Grouping

The self-rental recharacterization rule under Code Sec. 469 affects taxpayers who rent property to a trade or business in which they materially participate. Concern has been expressed over the possibility of interpreting net investment income under Code Sec. 1411 to include rental income from a self-rental activity grouped with a trade or business activity in which the taxpayer materially participates.

The material participation and trade or business requirements should be tested on the grouped activity as a whole rather than on a component basis, one expert in particular stressed at the hearing. If that test is passed, he argued, the trade or business income and rental income from the grouped activity should be excluded from the reach of the NII Tax. For example, the owners of self-rental properties should not have that rent considered as separate from their overall business activity and subject to the net investment tax simply because properties are held in a separate LLC to avoid tort liability.

Regrouping deadline

The proposed regulations permit businesses subject to the NII Tax to elect to regroup their activities for passive-loss purposes in 2013 or 2014. This regrouping election allows taxpayers with a fresh start to accommodate the new NII surtax. Without permitting regroupings, taxpayers would be bound by their original grouping decisions, some of which may have been made as many as 20 years ago, only for purpose of Code Sec. 469 passive loss rules and not the NII Tax. Some small business representatives are also concerned that, because of the complexity of the rules, the final regulations should extend the deadline for a regrouping election through 2015.

Application of the net investment income tax is particularly difficult to get a handle on in a variety of situations.  Unfortunately, however, at 3.8 percent, it is costly enough not to be ignored. 

If you have any questions about how the NII Tax may apply to your business, rental operations, or overall investment strategy, please do not hesitate to call our office.

Under the Patient Protection and Affordable Care Act (PPACA), small employers can claim a credit for providing health insurance for employees and their families. Health insurance includes not only basic medical and hospital care, but dental or vision, long-term care, and coverage for specific diseases or illness. Self-funded plans do not qualify; the insurance must be provided through a third party.

Under the Patient Protection and Affordable Care Act (PPACA), small employers can claim a credit for providing health insurance for employees and their families. Health insurance includes not only basic medical and hospital care, but dental or vision, long-term care, and coverage for specific diseases or illness. Self-funded plans do not qualify; the insurance must be provided through a third party.

For 2010-2013, for-profit employers can claim a credit of 35 percent of the employer's nonelective contributions, increasing to 50 percent for 2014 and 2015. Nonprofit employers can claim a credit of 25 percent through 2013, and 35 percent for the two succeeding years. Beginning in 2012, the credit for nonprofit employers is limited to the payroll taxes paid by the employer.

Small employers

Employers can claim the full credit if their full-time equivalent (FTE) employees are 10 or less, and their average annual wages per employee are $25,000 or less. FTEs are determined by figuring total hours of service for all employees and dividing the total by 2,080.

The credit is phased out for employers with 11 to 25 employees or with average wages between $25,000 and $50,000. The credit percentage is reduced 6.67 percent per "excess" employee (over 10) and four percent for each $1,000 of average wages in excess of $25,000.

To determine the amount of the credit, employers must add up the total premiums they paid on behalf of their employees during the year, subject to the state average premium limit. This total is then multiplied by the applicable percentage (25 or 35 percent for 2013, minus any phase-out). The credit is then reduced for FTEs in excess of 10, and for average annual wages (in units of $1,000) over $25,000. The result is the total credit that the employer can claim.

Other requirements

Under current law, employers must pay at least 50 percent of the insurance costs and must pay a uniform percentage for all employees. The credit is reduced if the employer premiums exceed the state's average premium for small group markets.

In its proposed fiscal year 2014 budget, the Obama administration would modify or eliminate some of these requirements. The credit phase-out would apply to employers with 21-50 employees, rather than 11-25. The phase-out rate would also be more gradual. Furthermore, the administration would eliminate the requirement that employers make a uniform contribution for each employee, and would eliminate the limit for state average premiums.

Reports indicate that the small business health insurance credit is being underutilized, with many businesses leaving this tax money on the table without claiming it or arranging their affairs to do so.

If you have any questions about how you might be able to position your business to claim this credit or claim a larger credit, do not hesitate to call this office for an update.

A business that manufactures products to be sold, or purchases products for resale, must value its product inventory at the beginning and the end of each tax year to determine the cost of goods sold (COGS) during the year. The business determines its gross profits by deducting COGS from its gross receipts for the year. The business then deducts its other business expenses from gross profits, to determine its net (taxable) income for the year.

A business that manufactures products to be sold, or purchases products for resale, must value its product inventory at the beginning and the end of each tax year to determine the cost of goods sold (COGS) during the year. The business determines its gross profits by deducting COGS from its gross receipts for the year. The business then deducts its other business expenses from gross profits, to determine its net (taxable) income for the year.

Certain expenses are included in COGS. Expenses that are included in COGS cannot be deducted again as a business expense. COGS expenses include:

• The cost of products or raw materials, including freight or shipping charges;
• The cost of storing products the business sells;
• Direct labor costs for workers who produce the products; and
• Factory overhead expenses.

Purchased inventory

If the business purchases its inventory for resale, its inventory costs are the invoice price plus transportation and other necessary expenses, less discounts.  Discounts that must be deducted from the costs of purchased inventory include trade discounts, manufacturer's rebates, and cash discounts.

Trade discounts are a reduction in the price of goods that a manufacturer or wholesaler provides to a retailer.  It includes a discount that is always allowed, regardless of the time of payment. A manufacturer's rebate is based on the dealer's purchases during the year. A cash discount is a reduction in the invoice price that the seller provides if the dealer pays immediately or within a specified time. The cash discount may reduce COGS, or it may be treated separately as gross income. Certain excise tax reimbursements may reduce the value of ending inventory and therefore reduce COGS.   

Methods of accounting

It is usually impractical to associate items of intermingled or fungible inventory with specific invoices and costs. Instead, taxpayers use certain assumptions or methods of accounting to identify the goods on hand and their costs. The traditional assumptions include FIFO (first-in, first-out) and LIFO (last-in, first-out). In some cases, specific identification is used. The courts have approved the average cost method, although the IRS disagrees with its use. The IRS will permit taxpayers to use other inventory cost assumptions, such as the rolling-average method, if they are reasonable for the taxpayer's trade or business and clearly reflect income.

Under the FIFO, the taxpayer is presumed to sell the oldest goods in inventory and to retain the most-recently produced or purchased items. If production (inventory) costs are rising, the use of FIFO reduces COGS and increases the taxpayer's income. Under LIFO, the taxpayer is presumed to sell the most recently obtained goods and to retain the oldest goods in inventory. Assuming that inventory costs are rising, the LIFO method will increase COGS and decrease the taxpayer's income. Under the average cost method, all units purchased during the year are averaged with the cost of beginning inventory, to determine an average cost.

As an individual or business, it is your responsibility to be aware of and to meet your tax filing/reporting deadlines. This calendar summarizes important tax reporting and filing data for individuals, businesses and other taxpayers for the month of May 2013.

As an individual or business, it is your responsibility to be aware of and to meet your tax filing/reporting deadlines. This calendar summarizes important tax reporting and filing data for individuals, businesses and other taxpayers for the month of May 2013.

May 1
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates April 24-26.

May 3
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates April 27-30.

May 8
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 1-3.

May 10
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 4-7.

Employees who work for tips. Employees who received $20 or more in tips during April must report them to their employer using Form 4070.

May 15
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 8-10.

May 17
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 11-14.

May 22
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 15-17.

May 24
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 18-21.

May 30
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 22-24.

May 31
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 25-28.

June 5
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 29-31.