Category Archives: Tax Planning

IRS already cut billions in tax refund checks

Millions of taxpayers have already received big refund checks, as the 2014 tax filing season seems to be humming along without a hitch. IRS issuing many refund checks already.

The Internal Revenue Service announced today that it issued $64.5 billion in refunds to 19.5 million taxpayers as of Feb. 7, a total dollar amount that was up 24% from the same time last year. The average refund check issued this year, $3,317, is also 4.6% larger than last year.
It’s not too surprising that this filing season is running more smoothly than last year, when the IRS lagged the previous year’s pace for issuing refunds throughout most of the filing season. The agency had to put off accepting certain tax forms until as late as March because it was updating its systems following the tax-code revamps caused by the fiscal-cliff legislation.

But taxpayers are also submitting their returns more quickly. The IRS received more than 27 million returns as of Feb. 7, up 2.5% from the same time in 2013. Nearly 96% of those were filed electronically. Samuel Hale, 21, a college student near Fort Worth, Texas, says his refund was deposited into his checking account Friday morning, a week after he filed his return electronically using online software. “I was very surprised,” says Hale, who couldn’t file his return until April last year because of a missing W-2 form.

In an interesting shift, the data shows more taxpayers are doing their own returns so far this tax season. Roughly half of the returns submitted, or 13.3 million, were self prepared, up 14.7% from last year. Typically, about 60% of returns are handled by a tax pro, according to IRS data.

Of course, not all taxpayers have been able to file their returns yet. Some people are still waiting on paperwork from their brokers, employers or colleges that they need to report all income and claim certain tax breaks. And some people aren’t eager to file their returns. Taxpayers who need to cut a check to the IRS generally wait until closer to April 15 to file.

Taxpayers can track their refunds using the “Where’s My Refund?” tool starting 24 hours after filing electronically, or four weeks after mailing in a return. About 90% of refunds are issued within 21 days, though some may be delayed if there is an issue with the return.

Discuss this and more on the Income Tax Forums.

2014 tax breaks: Congress letting 55 tax breaks expire at year end

WASHINGTON – In an almost annual ritual, Congress is letting a package of 55 popular tax breaks expire at the end of the year, creating uncertainty — once again — for millions of individuals and businesses.

Lawmakers let these tax breaks lapse almost every year, even though they save businesses and individuals billions of dollars. And almost every year, Congress eventually renews them, retroactively, so taxpayers can claim them by the time they file their tax returns.

2014 tax breaks: Congress letting 55 tax breaks expire at year endNo harm, no foul, right? After all, taxpayers filing returns in the spring won’t be hurt because the tax breaks were in effect for 2013. Taxpayers won’t be hit until 2015, when they file tax returns for next year.

Not so far. Trade groups and tax experts complain that Congress is making it impossible for businesses and individuals to plan for the future. What if lawmakers don’t renew the tax break you depend on? Or what if they change it and you’re no longer eligible?

“It’s a totally ridiculous way to run our tax system,” said Rachelle Bernstein, vice president and tax counsel for the National Retail Federation. “It’s impossible to plan when every year this happens, but yet business has gotten used to that.”

Some of the tax breaks are big, including billions in credits for companies that invest in research and development, generous exemptions for financial institutions doing business overseas, and several breaks that let businesses write off capital investments faster.

Others are more obscure, the benefits targeted to film producers, race track owners, makers of electric motorcycles and teachers who buy classroom supplies with their own money.

There are tax rebates to Puerto Rico and the Virgin Islands from a tax on rum imported into the United States, and a credit for expenses related to railroad track maintenance.

A deduction for state and local sales taxes benefits people who live in the nine states without state income taxes. Smaller tax breaks benefit college students and commuters who use public transportation.

A series of tax breaks promote renewable energy, including a credit for power companies that produce electricity with windmills.

The annual practice of letting these tax breaks expire is a symptom a divided, dysfunctional Congress that struggles to pass routine legislation, said Rep. John Lewis of Georgia, a senior Democrat on the tax-writing House Ways and Means Committee.

“It’s not fair, it’s very hard, it’s very difficult for a business person, a company, to plan, not just for the short term but to do long-term planning,” Lewis said. “It’s shameful.”

With Congress on vacation until January, there is no chance the tax breaks will be renewed before they expire. And there is plenty of precedent for Congress to let them expire for months without addressing them. Most recently, they expired at the end of 2011, and Congress didn’t renew them for the entire year, waiting until New Year’s Day 2013 — just in time for taxpayers to claim them on their 2012 returns.

But Congress only renewed the package though the end of 2013.

Why such a short extension? Washington accounting is partly to blame. The two-year extension Congress passed in January cost $76 billion in reduced revenue for the government, according to the nonpartisan Joint Committee on Taxation. Making those tax breaks permanent could add $400 billion or more to the deficit over the next decade.

With budget deficits already high, many in Congress are reluctant to vote for a bill that would add so much red ink. So, they do it slowly, one or two years at time.

“More cynically, some people say, if you just put it in for a year or two, then that keeps the lobbyists having to come back and wine-and-dine the congressmen to get it extended again, and maybe make some campaign contributions,” said Mark Luscombe, principal tax analyst for CCH, a consulting firm based in Riverwoods, Ill.

This year, the package of tax breaks has been caught up in a debate about overhauling the entire tax code. The two top tax writers in Congress — House Ways and Means Committee Chairman Dave Camp, R-Mich., and Senate Finance Committee Chairman Max Baucus, D-Mont. — have been pushing to simplify the tax code by reducing tax breaks and using the additional revenue to lower overall tax rates.

But their efforts have yet to bear fruit, leaving both tax reform and the package of temporary breaks in limbo. When asked how businesses should prepare, given the uncertainty, Camp said: “They need to get on board with tax reform, that’s what they need to do.”

Further complicating the issue, President Barack Obama has nominated Baucus to become U.S. ambassador to China, meaning he will soon leave the Senate, if he is confirmed by his colleagues.

As the Senate wound down its 2013 session, Democratic leaders made a late push to extend many of the tax breaks by asking Republican colleagues to pass a package on the floor of the Senate without debate or amendments. Republicans objected, saying it wasn’t a serious offer, and

the effort failed.

So should taxpayers count on these breaks as they plan their budgets for Income Tax 2014?

“The best thing I would say is, budget accordingly,” said Jackie Perlman, principle tax research analyst at The Tax Institute. “As the saying goes, hope for the best but plan for the worst. Then if you get it, great, that’s a nice perk. But don’t count on it.”

Discuss this and more at the Income Tax Forums.

IRS Delays Start of 2014 U.S. Tax Filing Citing Shutdown

IRS Delays Start of 2014 U.S. Tax Filing Citing ShutdownThe U.S. Internal Revenue Service delayed the start of the tax-filing season for one to two weeks, citing the recent 16-day federal government shutdown.

The IRS, which had been scheduled to open filing Jan. 21, 2014, will now begin accepting returns for tax year 2013 as early as Jan. 28. The agency will make a final decision on the date in December, according to a statement today.

“Readying our systems to handle the tax season is an intricate, detailed process, and we must take the time to get it right,” Danny Werfel, the acting IRS commissioner, said in the statement.

This is the second year in a row that the IRS has postponed the filing season. Returns for 2012 were accepted starting on Jan. 30 after Congress delayed setting some tax policies.

“Considering the IRS has dealt with much larger changes on far shorter notice over the past years without delay, its reasons are suspect,” Sarah Swinehart, a spokeswoman for the Republican-led House Ways and Means Committee, said in an e-mail.

The IRS furloughed more than 90 percent of its employees during the shutdown, which began Oct. 1 when Congress was unable to pass a spending bill and ended after midnight Oct. 17.

‘Adds Insult’

“This is yet another unfortunate effect of a shutdown that Republicans should have never caused,” Representative Sander Levin of Michigan, the top Democrat on the Ways and Means Committee, said in a statement. “This tax-filing delay just adds insult to injury for Americans hoping to get a jump-start on their tax refunds in January.”

The delay won’t alter the April 15 deadline for taxpayers to file their returns or seek extensions.

At the start of the filing season, the IRS largely issues refunds to taxpayers who file as soon as they can. This year, the IRS issued $135 billion in refunds from Jan. 30 to March 1. That’s more than was paid from March 2 to May 10, when the agency received 50 percent more returns.

Delaying refunds could have an additional consequence in 2014. The U.S. debt limit is suspended through Feb. 7, and changes in the government’s projected spending after that date will affect the timing of how long the Treasury Department’s extraordinary measures to prevent a default will last.

Because the government may issue more refunds after Feb. 7 than previously anticipated, a potential lapse in borrowing authority could come a few days sooner than projected, said Loren Adler, research director at the Committee for a Responsible Federal Budget in Washington.

The delayed start of tax-filing season probably will create a backlog of potential returns for the start date, rather than delaying all returns equally.

“Those are folks who are trying to do this as soon as their books are in order,” Adler said.

The Bipartisan Policy Center projects that the U.S. will run out of borrowing authority between the end of February and mid-March 2014.

Discuss this and more in the Income Tax Forums.

Late Start for I.R.S. 2012 Income Tax Processing

Bad news coming out of the IRS today. The IRS will not start processing 2012 Income Tax Returns until January 30th, 2013.

Here is the article from the IRS:

IRS Plans Jan. 30 Tax Season Opening For 1040 Filers

IR-2013-2, Jan. 8, 2013

WASHINGTON — Following the January tax law changes made by Congress under the American Taxpayer Relief Act (ATRA), the Internal Revenue Service announced today it plans to open the 2013 filing season and begin processing individual income tax returns on Jan. 30.

The IRS will begin accepting tax returns on that date after updating forms and completing programming and testing of its processing systems. This will reflect the bulk of the late tax law changes enacted Jan. 2. The announcement means that the vast majority of tax filers — more than 120 million households — should be able to start filing tax returns starting Jan 30.

The IRS estimates that remaining households will be able to start filing in late February or into March because of the need for more extensive form and processing systems changes. This group includes people claiming residential energy credits, depreciation of property or general business credits. Most of those in this group file more complex tax returns and typically file closer to the April 15 deadline or obtain an extension.

“We have worked hard to open tax season as soon as possible,” IRS Acting Commissioner Steven T. Miller said. “This date ensures we have the time we need to update and test our processing systems.”

The IRS will not process paper tax returns before the anticipated Jan. 30 opening date. There is no advantage to filing on paper before the opening date, and taxpayers will receive their tax refunds much faster by using e-file with direct deposit.

“The best option for taxpayers is to file electronically,” Miller said.

The opening of the filing season follows passage by Congress of an extensive set of tax changes in ATRA on Jan. 1, 2013, with many affecting tax returns for 2012. While the IRS worked to anticipate the late tax law changes as much as possible, the final law required that the IRS update forms and instructions as well as make critical processing system adjustments before it can begin accepting tax returns.

The IRS originally planned to open electronic filing this year on Jan. 22; more than 80 percent of taxpayers filed electronically last year.

Who Can File Starting Jan. 30?

The IRS anticipates that the vast majority of all taxpayers can file starting Jan. 30, regardless of whether they file electronically or on paper. The IRS will be able to accept tax returns affected by the late Alternative Minimum Tax (AMT) patch as well as the three major “extender” provisions for people claiming the state and local sales tax deduction, higher education tuition and fees deduction and educator expenses deduction.

Who Can’t File Until Later?

There are several forms affected by the late legislation that require more extensive programming and testing of IRS systems. The IRS hopes to begin accepting tax returns including these tax forms between late February and into March; a specific date will be announced in the near future.

The key forms that require more extensive programming changes include Form 5695 (Residential Energy Credits), Form 4562 (Depreciation and Amortization) and Form 3800 (General Business Credit). A full listing of the forms that won’t be accepted until later is available on IRS.gov.

As part of this effort, the IRS will be working closely with the tax software industry and tax professional community to minimize delays and ensure as smooth a tax season as possible under the circumstances.

Updated information will be posted on IRS.gov.

More information here.

Individual 1040(ez) Tax Preparation

Also, a small note, If you have a copy of your prior year .tax return and your final pay stub from work. We can file starting January 3rd for you at no initial charge. Your payment will be paid out of your tax refund. Not have a bank account? No problem. We can have a check mailed or get the same card for you that you would get through a tax company. Contact us today for an appointment.

 

Taxes@HotSpringsTaxServices.com

(501) 216-0587

Get Your Income Tax Refund by January 28th 2013!

Get Your Income Tax Refund by January 28th 2013!

We finally have information about the Refund Calendar from the I.R.S. To see the dates that checks will be refunded, click here. We will actually be able to start filing on January 3rd 2013. This is the date that all of the tax forms needed will be available from the I.R.S. If you are interested in filing on this date, we will need your final 2012 pay check and a copy of your 2011 Tax Return that you filed in 2012.

If you are a returning client, we will just need your last pay stub from 2012 and any other information such as deductible expenses. We will still go over and make sure that we are not missing any 2012 information that could result in deductions or credits.

Contact us today to schedule an appointment via email or in office for January 2013! Appointments are limited, so please contact us as soon as possible!

2013 IRS e-file Refund Cycle Chart for Tax Year 2012

 Income Tax Refund Schedule 2012 Tax Payments

Income Tax Refund Calendar 2012

Income Tax Refund 2013

Income Tax Refund 2013

Taxes@HotSpringsTaxServices.com

Tax Rate Changes to Take Affect January 1st 2013

Much has been written about changes to the estate and gift tax law scheduled to occur on January 1, 2013, particularly the reduction of the lifetime estate and gift tax exemption amount from its 2012 level of $5,120,000 to $1 million. The exemption for the generation-skipping transfer tax will also decrease from its 2012 level of $5,120,000 to a base level of $1 million. It is indexed for inflation from 2001, however, and is currently estimated to be $1,430,000. Significant changes to the income tax law are also scheduled to take effect at the same time, but these changes are only now beginning to receive similar attention. While Congress could still act to avert some or all of the changes, the divided nature of this Congress makes the prospect of any action before January 1, 2013, uncertain. This alert summarizes the most significant of the changes to the income tax law that will take effect on January 1, 2013, and suggests some steps you might consider to mitigate their impact.

Tax Rates

The maximum federal income tax rate on ordinary income will increase from its present level of 35 percent to 39.6 percent. The tax rate on long-term capital gain income will increase from its present level of 15 percent to 20 percent. The most dramatic increase will be to the rate at which qualified dividends are taxed. Qualified dividends are currently taxed at the same 15 percent rate as long-term capital gain income. Beginning January 1, 2013, dividends will be treated the same as other ordinary income and taxed at a maximum income tax rate of 39.6 percent.

Additional Medicare Taxes

Now that the U.S. Supreme Court has upheld the Patient Protection and Affordable Care Act of 2010, the additional Medicare taxes will take effect January 1, 2013, as planned, unless Congress acts to change them.

Employees currently pay a Medicare hospital insurance tax of 1.45 percent on their wages. Self-employed individuals pay 2.9 percent of net earnings from self-employment. Unlike taxes on wages and self-employment income for Old Age, Survivors and Disability Insurance, which are capped, the Medicare component of the social security tax has no ceiling. Beginning January 1, 2013, an additional 0.9 percent tax will apply to wages in excess of $250,000 for a married person filing a joint return ($125,000 for married persons filing separately) or $200,000 for an unmarried individual. This will make the total Medicare tax for these individuals 2.35 percent on their wages above the threshold amount. For self-employed individuals, the additional 0.9 percent will apply to their earnings from self-employment in excess of $250,000 for a married person filing a joint return ($125,000 for married persons filing separately) or $200,000 for an unmarried individual. The total Medicare tax for these individuals will be 3.8 percent on their earnings above the threshold amounts, which are not currently indexed for inflation.

Medicare Tax on Investment Income

A new Medicare tax on net investment income will also take effect beginning January 1, 2013. The rate for this new tax will be 3.8 percent and will apply to the lesser of an individual’s i) net investment income; or ii) the excess of the individual’s “modified adjusted gross income” over $250,000 in the case of a married couple filing a joint return ($125,000 for married persons filing separately or an unmarried individual). Modified adjusted gross income is the adjusted gross income increased by the amount of the foreign earned income exclusion. For most taxpayers, their modified adjusted gross income will be the same as their adjusted gross income. The threshold amounts are not currently indexed for inflation.

In the case of an estate or trust that accumulates part of its income, the tax will apply to the lesser of i) its undistributed net investment income; or ii) the excess of its adjusted gross income over the dollar amount at which the highest tax bracket in Section 1(e) begins for the taxable year. This amount currently is scheduled to be $7,500. Since this is a much lower threshold amount than applies to individuals, in many cases, net investment income may be subject to the Medicare tax if it accumulated at the trust level, while it would not be subject to the tax if it is distributed to beneficiaries whose adjusted gross income is less than $250,000 if they file a joint return, or $200,000 if they are unmarried.

Net investment income is gross investment income reduced by those allowable deductions that are properly allocable to such income. Investment income includes interest, dividends, annuities, royalties, and rents, provided that this income is not derived from a trade or business that is not a passive activity for the taxpayer. It also includes gains from the disposition of property, so capital gains realized on the sale of appreciated investments will be subject to this new tax, as well as income derived from the business of trading financial instruments or commodities. If a business that is a passive activity for the taxpayer earns any of the above types of income, that income is also subject to the tax.

The tax does not apply to amounts distributed from qualified retirement plans. It also does not apply to any amount that is subject to the self-employment tax. This rule prevents the Medicare tax from applying twice to the same income. While income from a trade or business that is not a passive activity of the taxpayer will not be subject to the 3.8 percent Medicare tax on investment income, much of that income may be subject to the 3.8 percent Medicare tax on self-employment income. Some limited types of income may not be subject to either tax, but a lot of the detail on how the new tax will apply is still missing.

Phase-out of Itemized Deductions and Personal Exemptions

The phasing out of itemized deductions will also return to the tax law in 2013. Once again, an amount of a taxpayer’s itemized deductions equal to 3 percent of adjusted gross income in excess of $100,000 (adjusted for inflation) will be disallowed, but not in excess of 80 percent of the taxpayer’s total itemized deductions. The disallowance rule applies to all of a taxpayer’s itemized deductions except for medical expenses, investment interest, and casualty and theft losses. For 2009, the last year to which the phase-out previously applied, the $100,000 amount had been inflation adjusted to $166,800. The amount for 2013 should be announced soon.

The personal exemption deduction of $3,700 (2011 amount) per taxpayer and dependent will once again be phased out. The deduction is phased out at the rate of 2 percent of the deduction for each $2,500 by which the taxpayer’s adjusted gross income exceeds a threshold amount. The amount is inflation adjusted and for 2009, the last year to which the phase-out applied, was $250,200 for taxpayers filing a joint return. The deductions were completely lost if the taxpayer’s adjusted gross income exceeded $372,700. The deduction amount and the threshold amount where the phase-out begins for 2013 should be announced soon.

What Should You Do to Prepare for 2013?

You should be prepared to take certain steps after the November elections and before the end of the year if it becomes apparent that Congress will not act to extend the current tax regime into 2013. Some of the considerations are described below.

Should You Sell Appreciated Capital Assets in 2012?

The idea of selling appreciated capital assets in 2012 and paying a federal tax of 15 percent, as compared to a tax of 23.8 percent after 2012, certainly has appeal, since the applicable rate is increasing by 58.67 percent of its present level. Even if you do not wish to part with a particular position, in the case of publicly traded securities, you can easily re-base an appreciated securities position by selling it and then buying the same security. No “wash gain” rule comparable to the wash sale rule for losses applies, and you can sell an asset at a gain today and buy the same asset tomorrow.

Whether this strategy will prove to be a winner over time, however, depends on a number of factors that often are difficult to quantify. Selling earlier than you otherwise would have sold means paying the resulting tax sooner, and once you pay the tax, that money no longer generates further returns for you. By keeping the amount you would have paid in taxes invested on a pre-tax basis, you might eventually generate enough additional return to offset the higher tax rate, or more.

You can model various scenarios, but the result the model generates will only be as accurate as the assumptions you build into it. You will need to predict the time you would otherwise sell the asset, how much the asset might appreciate between now and that time, and the tax rate that might apply. You must also take into account the transaction costs of selling and re-establishing the position. Taxpayers who are elderly or in failing health may want to hold appreciated positions because a basis increase to fair market value at death will still apply.

At the extremes, you can pretty easily determine what to do. For example, if you have a substantially appreciated stock position that you believe you would normally sell in 2013, it almost certainly will be advantageous to sell that holding in 2012. On the other hand, if you have a position that you expect to hold for 15 more years, you are most likely better off just keeping the position and not reducing your invested assets by paying tax now. Over a period of 15 years, by keeping the amount of tax you would pay now invested and generating additional return, you will most likely earn enough to pay the increased amount of income tax that will be due at the time you do sell the asset. You also need to consider the most effective use of capital loss carryovers you might have.

Between these extreme cases, however, the analysis becomes more difficult. The future holding period of the asset and the future return on it are inversely correlated. As the asset’s future rate of return increases, the additional time that the asset must be held to overcome the higher tax rate decreases. As a rule of thumb, you might at least consider re-basing positions that you expect to sell within the next five years, and we are available to assist you in evaluating specific situations. Also, do not forget that the early payment of any applicable state income taxes will further diminish the amount of your invested capital going forward.

Many people have done quite well by operating on a philosophy that says the future is uncertain and you should never pay any tax until you absolutely must, a reasonable position to adopt in many cases.

Do Dividend-yield Stock Portfolios Still Make Sense?

If your investment portfolio is significantly weighted in favor of high-dividend-paying stocks, you should probably ask your investment advisor whether this strategy continues to make sense for you in an environment where the tax rate on dividends is nearly three times what it was when the portfolio was established. While a greater emphasis on growth stocks or other asset classes may be appropriate, you should make that decision only after a discussion with your investment advisor.

Should You Accelerate Ordinary Income?

The acceleration of ordinary income into 2012 could have certain advantages. The 2012 maximum federal income tax rate on ordinary income is 35 percent, as compared to the 2013 rate of 39.6 percent, or 43.4 percent if the income is investment income subject to the 3.8 percent Medicare tax on net investment income. Having a higher adjusted gross income in 2012 and a comparatively lower adjusted gross income in 2013 may also ameliorate to some degree the impact of the itemized deduction phase-out that will apply again in 2013. Acceleration of income is even more attractive if you will be paying AMT (Alternative Minimum Tax) in 2012 and can recognize additional ordinary income subject to a 28 percent tax rate.

If you have discretion to accelerate a bonus or other earned income into 2012 instead of 2013, you can also avoid the 0.9 percent increase in the Medicare tax on wages or net earnings from self-employment that will occur in 2013.

If you are able to control the payment of dividends by a “C” corporation or an “S” corporation that has accumulated earnings from prior “C” corporation years, it may be advantageous to pay dividends in 2012 while the federal income tax rate is 15 percent, as compared to 2013 and later years when the rate may be as high as 43.4 percent.

Consider Roth IRA Conversions

It may also be worthwhile to visit or re-visit the subject of Roth IRA conversions before the end of 2012. The maximum income tax rate that will apply to the taxable amount of a Roth conversion in 2012 is 35 percent, as compared to 39.6 percent if the conversion occurs in 2013 or later. While income from a qualified retirement account is not subject to the 3.8 percent Medicare tax on net investment income, the income from the conversion will increase your adjusted gross income. In 2013 or later, if a Roth conversion causes your adjusted gross income to increase from an amount below $250,000 (on a joint return) to an amount above $250,000, the conversion will result in at least a part of your net investment income becoming subject to the Medicare tax. A Roth conversion after 2012 will also result in an additional disallowance of itemized deductions, since that disallowance also increases as your adjusted gross income increases.

What about Itemized Deductions?

Whether you are better off accelerating or deferring itemized deductions is somewhat complicated. Superficially, deferring discretionary payments (e.g., many charitable contributions and some state income taxes) from 2012 to 2013 makes sense because the deduction may result in greater tax savings due to the higher tax rate that will apply in 2013. The phase-out of itemized deductions will also have an impact, however. If a significant portion of the deduction would be disallowed under the phase-out rules in 2013, then you may be better off taking the deduction in 2012, albeit against a lower tax rate. In the case of charitable contributions, another risk of deferring contributions to 2013 is that Congress could always eliminate the deduction at fair market value for contributions of appreciated property. Certain itemized deductions, such as state income taxes, are not deductible for purposes of computing the AMT, so you are better off paying those kinds of expenses in a year where you have less exposure to the AMT.

Conclusion

While other changes to the income tax law also will take effect in 2013, the ones summarized above are the most significant for higher-income taxpayers. If you would like our assistance in evaluating your particular situation and determining your best course of action, please feel free to contact us.

2013 Income Tax Update

Overview

This may be the final year that the so-called Bush tax cuts remain in effect, unless Congress acts to further extend them. The Bush tax cuts, enacted in 2001 and 2003, were originally scheduled to expire for tax years beginning in 2011. However, President Obama signed legislation in late 2010 that temporarily extended the Bush tax cuts through 2012.

Many commentators agree that Congress is unlikely to extend the Bush tax cuts prior to the November elections, but uncertainty remains as to whether Congress will take action following the elections. Provided that Congress fails to extend the Bush tax cuts, many significant rate changes and other substantive changes will take effect in 2013. This article summarizes the major federal income tax changes that are scheduled take effect in 2013 if Congress allows the Bush tax cuts to expire, certain other changes scheduled to take effect independent of the Bush tax cuts, and planning strategies to reduce the impact of these changes. If you or your company would like to discuss any of these scheduled changes or planning strategies, please contact any member of the Tax and Employee Benefits Team.

Individual Income Tax Rates

If Congress allows the Bush tax cuts to expire, ordinary income tax rates will increase for most individual taxpayers beginning in 2013. As discussed below, qualified dividend income that is currently taxed at long-term capital gain rates will be taxed at these higher ordinary income rates. The following table sets forth the scheduled rate increases, using 2012 dollar amounts which will be adjusted for inflation in 2013.

Tax Brackets (2012 Dollar Amounts) Marginal Rate
Unmarried Filers Married Joint Filers
Over But Not Over Over But Not Over 2012 2013
$0 $8,700 $0 $17,400 10% 15%
8,700 35,350 17,400 70,700* 15% 15%
35,350 85,650 70,700* 142,700 25% 28%
85,650 178,650 142,700 217,450 28% 31%
178,650 388,350 217,450 388,350 33% 36%
388,350 388,350 35% 39.6%

* In 2013, this dollar amount will decrease to 167% of the amount for unmarried taxpayers in the same bracket (which is $58,900 in 2012), rather than 200% of the amount for unmarried taxpayers under current law. This change will have the effect of putting more middle-income joint filers in the 28% bracket and increasing the “marriage penalty” for many taxpayers.

Long-Term Capital Gain Rates

The maximum rate on long-term capital gain is scheduled to increase from 15 to 20 percent in 2013. Individual taxpayers in the 10 and 15 percent ordinary income tax brackets currently pay no tax on long-term capital gain. These taxpayers are scheduled to be subject to a 10 percent long-term capital gain rate in 2013. An 18 percent maximum rate will apply to capital assets purchased after 2000 and held for more than five years. Additionally, the 3.8 percent Medicare contribution tax discussed below will increase the effective rate of tax on long-term capital gains for certain higher-income taxpayers to as high as 23.8 percent. The following table sets forth the scheduled rate increases.

Maximum Rates 2012 2013 2013 (including Medicare contribution tax)
Long-Term Capital Gain 15% 20% 23.8%
Qualified 5-Year Capital Gain 15% 18% 21.8%

Planning Strategies. If Congress fails to take action as the year-end approaches, investors who were otherwise considering selling appreciated stocks or securities in early 2013 should give additional consideration to selling in 2012 to take advantage of the lower rate, assuming they will have held the asset for longer than one year. Additionally, business owners who are considering selling their business in the near future should consult with their tax adviser to discuss whether electing out of the installment method for an installment sale in 2012 would be more advantageous from a tax planning perspective.

Dividend Income Rates

The Bush tax cuts created the concept of “qualified dividend income,” which currently allows dividends received from domestic corporations and certain foreign corporations to be taxed at the taxpayer’s long-term capital gain rate. Additionally, qualified dividend income earned by mutual funds and exchange-traded funds may be distributed to shareholders and treated as qualified dividend income by the shareholder. Prior to the Bush tax cuts, all dividend income was taxed as ordinary income. If Congress fails to extend these provisions, the qualified dividend income provisions will expire, and all dividends will once again be taxed as ordinary income. Most notably, taxpayers in the highest marginal income tax bracket who currently enjoy the 15 percent rate on qualified dividend income will be taxed at 39.6 percent for dividends received from the same issuer in 2013. Additionally, the 3.8 percent Medicare contribution tax discussed below will increase the effective rate of tax on dividend income for certain higher-income taxpayers to as high as 43.4 percent. The following table sets forth the scheduled rate increases.

Maximum Rates 2012 2013 2013 (including Medicare contribution tax)
Qualified Dividend Income 15% 39.6% 43.4%
Ordinary Dividend Income 35% 39.6% 43.4%

Planning Strategies. Because of the impending increase to tax rates applicable to dividends, owners of closely held corporations should consider declaring and paying a larger-than-normal dividend this year if the corporation has sufficient earnings and profits. Owners should carefully plan any such distributions, as distributions in excess of the corporation’s earnings and profits will reduce the shareholder’s stock basis and subject the shareholder to increased long-term capital gain taxable at potentially higher rates when the shareholder subsequently disposes of the stock. Owners of closely held corporations should consult their tax adviser to discuss dividend planning and other strategies such as leveraged recapitalizations to take advantage of the low rate currently applicable to qualified dividend income.

New Medicare Contribution Tax

A new 3.8 percent Medicare contribution tax on certain unearned income of individuals, trusts, and estates is scheduled to take effect in 2013. This provision, which was enacted as part of the Patient Protection and Affordable Care Act (PPACA), is scheduled to take effect regardless of whether Congress extends the Bush tax cuts. For individuals, the 3.8 percent tax will be imposed on the lesser of the individual’s net investment income or the amount by which the individual’s modified adjusted gross income (AGI) exceeds certain thresholds ($250,000 for married individuals filing jointly or $200,000 for unmarried individuals). For purposes of this tax, investment income includes interest, dividends, income from trades or businesses that are passive activities or that trade in financial instruments and commodities, and net gains from the disposition of property held in a trade or business that is a passive activity or that trades in financial instruments and commodities. Investment income excludes distributions from qualified retirement plans and excludes any items that are taken into account for self-employment tax purposes.

Planning Strategies. Until the Department of Treasury issues clarifying regulations, uncertainty remains regarding which types of investment income will be subject to this new tax. Taxpayers whose modified AGI exceeds the thresholds described above should consult their tax adviser to plan for the imposition of this tax. Specifically, business owners should discuss with their tax adviser whether it would be more advantageous to become “active” in their business rather than “passive” for purposes of this tax. Owners of certain business entities such as partnerships and LLCs should also consider whether a potential change to “active” status in the business could trigger self-employment tax liability. Investors in pass-through entities such as partnerships, LLCs, and S corporations should also review the tax distribution language in the relevant entity agreement to ensure that future tax distributions will account for this new tax.

Additionally, individuals will have a greater incentive to maximize their retirement plan contributions since distributions from qualified retirement plans are not included in investment income for purposes of the tax. While distributions from traditional IRAs and 401(k) plans are not included in investment income for purposes of the tax, they do increase an individual’s modified AGI and may push the individual above the modified AGI threshold, thus subjecting the individual’s other investment income to the tax. Individuals may also consider converting their traditional retirement plan into a Roth IRA or Roth 401(k) this year since Roth distributions are not included in investment income and do not increase the individual’s modified AGI. Although the Roth conversion would be taxable at ordinary rates, individuals should consider converting this year to avoid the higher ordinary rates scheduled to take effect in 2013.

Reduction in Itemized Deductions

Under current law, itemized deductions are not subject to any overall limitation. If the Bush tax cuts expire, an overall limitation on itemized deductions for higher-income taxpayers will once again apply. Most itemized deductions, except deductions for medical and dental expenses, investment interest, and casualty and theft losses, will be reduced by the lesser of 3 percent of AGI above an inflation-adjusted threshold or 80 percent of the amount of itemized deductions otherwise allowable. The inflation-adjusted threshold is projected to be approximately $174,450 in 2013 for all taxpayers except those married filing separately.

Planning Strategies. Because the overall limitation on itemized deductions will automatically apply to higher-income taxpayers, planning strategies are limited and highly individualized. Accelerating certain itemized deductions in 2012 to avoid the limitation may trigger alternative minimum tax (AMT) liability in 2012. Taxpayers should consult with their tax adviser to discuss the impact of this limitation and whether it may be advantageous to accelerate certain deductions, if possible, to 2012.

Reduction in Election to Expense Certain Depreciable Business Assets

Taxpayers may currently elect to expense certain depreciable business assets (Section 179 assets) in the year the assets are placed into service rather than capitalize and depreciate the cost over time. Section 179 assets include machinery, equipment, other tangible personal property, and computer software. Computer software falls out of this definition in 2013. The maximum allowable expense cannot exceed a specified amount, which is reduced dollar-for-dollar by the amount of Section 179 assets placed into service exceeding an investment ceiling. Both the maximum allowable expense and the investment ceiling will decrease next year, as shown in the table below.

2012 2013
Maximum allowable expense $139,000 $25,000
Investment ceiling 560,000 200,000

Planning Strategies. The change in law will both significantly decrease the dollar amount of Section 179 assets that may be expensed and cause the phaseout to be triggered at a lower threshold. Accordingly, business owners should consider placing Section 179 assets into service in 2012 to take advantage of the immediate tax benefit. Additionally, purchases of qualifying computer software should accelerated to 2012 if possible, as such purchases will no longer qualify for expensing in 2013.

AMT Preference for Gain Excluded on Sale of Qualified Small Business Stock

Taxpayers may exclude from their income all or part of the gain from selling stock of certain qualified C corporations that the taxpayer held for more than five years. The percentage of gain that may be excluded depends upon when the taxpayer acquired the stock (a 100 percent exclusion applies only to qualified stock acquired between September 28, 2010 and December 31, 2011). Under current law, 7 percent of the excluded gain is a preference item for AMT purposes. In 2013, this tax preference is scheduled to increase to 42 percent of the excluded gain (or 28 percent of the excluded gain for stock acquired after 2000). Gain excluded on stock for which the 100 percent exclusion applies will not be a tax preference for AMT purposes.

Planning Strategies. The increase in the percentage of excluded gain that will be treated as a tax preference for AMT purposes effectively eliminates the tax benefit of selling qualified small business stock. Those who are structuring a new business venture should reconsider forming a C corporation to take advantage of this provision, and should consult with their tax adviser to consider other entity choices. Owners of qualifying businesses who are considering selling their stock in the near future should also give additional consideration to a 2012 sale to take advantage of the current 7 percent AMT preference rate before the AMT preference rate increases in 2013.

Built-in Gains Tax Applicable to Certain S Corporations

Businesses that have converted from a C corporation to an S corporation are potentially subject to a corporate-level 35 percent built-in gains tax (BIG tax) on the disposition of their assets to the extent that the aggregate fair market value of the corporation’s assets exceeded the aggregate basis of such assets on the conversion date. In the case of fiscal years beginning in 2011, the BIG tax does not apply if the five-year anniversary of the conversion date has occurred prior the beginning of the fiscal year. However, in the case of fiscal years beginning in 2012 or thereafter, the BIG tax will not apply only if the ten-year anniversary of the conversion date has occurred prior to the beginning of the fiscal year.

Planning Strategies. Owners of S corporations that are still in their 2011 fiscal year and that are considering selling corporate assets (or stock if a Section 338(h)(10) election will be made) within the near future should consider selling in the current fiscal year, if possible, to the extent their conversion to S corporation status occurred more than five, but less than ten years prior to the beginning of the fiscal year. For example, a C corporation that converted to an S corporation at the beginning of its fiscal year commencing October 1, 2005 would not be subject to the BIG tax on any of its built-in gain if it sold assets at any time prior to September 30, 2012, but would be subject to the tax if it sold assets on or after October 1, 2012.

Other Changes Affecting Individuals

  • Additional employee portion of payroll tax. The employee portion of the hospital insurance payroll tax will increase by 0.9 percent (from 1.45 percent to 2.35 percent) on wages over $250,000 for married taxpayers filing jointly and $200,000 for other taxpayers. The employer portion of this tax remains 1.45 percent for all wages. This provision, which was enacted as part of the PPACA, is scheduled to take effect in 2013 regardless of whether Congress extends the Bush tax cuts.
  • Phaseout of personal exemptions. A higher-income taxpayer’s personal exemptions (currently $3,800 per exemption) will be phased out when AGI exceeds an inflation-indexed threshold. The inflation-adjusted threshold is projected to be $261,650 for married taxpayers filing jointly and $174,450 for unmarried taxpayers.
  • Medical and Dental Expense Deduction. As part of the PPACA, the threshold for claiming the itemized medical and dental expense deduction is scheduled to increase from 7.5 to 10 percent of AGI. The 7.5 percent threshold will continue to apply through 2016 for taxpayers (or spouses) who are 65 and older.
  • Decrease in standard deduction for married taxpayers filing jointly. The standard deduction for married taxpayers filing jointly will decrease to 167% (rather than the current 200%) of the standard deduction for unmarried taxpayers (currently $5,950). In 2012 dollars, this would lower the standard deduction for joint filers from $11,900 to $9,900.
  • Above-the-line student loan interest deduction. This deduction will apply only to interest paid during the first 60 months in which interest payments are required, whereas no such time limitation applies under current law. The deduction will phase out over lower modified AGI amounts, which are projected to be $75,000 for joint returns and $50,000 for all other returns.
  • Income exclusion for employer-provided educational assistance. This exclusion, which allows employees to exclude from income up to $5,250 of employer-provided educational assistance, is scheduled to expire.
  • Home sale exclusion. Heirs, estates, and qualified revocable trusts (trusts that were treated as owned by the decedent immediately prior to death) will no longer be able to take advantage of the $250,000 exclusion of gain from the sale of the decedent’s principal residence.
  • Credit for household and dependent care expenses. Maximum creditable expenses will decrease from $3,000 to $2,400 (for one qualifying individual) and from $6,000 to $4,800 (for two or more individuals). The maximum credit will decrease from 35 percent to 30 percent of creditable expenses. The AGI-based reduction in the credit will begin at $10,000 rather than $15,000.
  • Child credit. The maximum credit will decrease from $1,000 to $500 per child and cannot be used to offset AMT liability.
  • Earned Income Tax Credit. The phaseout ranges for claiming the credit, which vary depending on the number of qualifying children, are scheduled to decrease for joint returns. Further, the credit will be reduced by the taxpayer’s AMT liability.

Other Withholding Rate Changes
The following employer withholding rate changes will take effect in 2013:

2012 2013
Employee portion of FICA payroll taxes 4.2% 6.2%
Backup withholding rate on reportable payments 28% 31%
Minimum witholding rate under flat rate method…
…on supplemental wages up to $1 million 25% 28%
…on supplemental wages in excess of $1 million 35% 39.6%
Voluntary withholding rate on unemployment benefits 10% 15%

Foreign Account Tax Compliance Act

Regardless of whether Congress extends the Bush tax cuts, beginning in 2014, a new 30 percent withholding tax will be imposed on certain withholdable payments paid to foreign financial institutions (FFIs) and non-financial foreign entities (NFFEs) unless they collect and disclose to the IRS information regarding their direct and indirect U.S. account holders. FFIs include foreign entities that accept deposits in the ordinary course of a banking or similar business, that hold financial assets for the account of others as a substantial part of their business, or that are engaged primarily in the business of investing or trading in securities, commodities, and partnership interests. Any foreign entity that is not an FFI is an NFFE.

Withholdable payments will include U.S.-source interest, dividends, fixed or determinable annual or periodical income, and U.S.-source gross proceeds from sales of property that produce interest and dividend income. While the withholding obligation on withholdable payments to FFIs and NFFEs does not begin until 2014, FFIs will need to enter into agreements with the IRS by June 30, 2013 to avoid being subject to the withholding tax. In general, under such agreements, FFIs must agree to provide the IRS with certain information including the name, address, taxpayer identification number and account balance of direct and indirect U.S. account holders, and must agree to comply with due diligence and other reporting procedures with respect to the identification of U.S. accounts.

2013 Tax Planning: 5 Reasons to Start Now

1. The 2013 Tax Season Is Closer than You Think

 

Industry experts generally agree that proper tax planning takes an average of six months – the time it often takes experts to educate themselves on all available opportunities, determine the best approach, and implement the plan. When you consider that six months from today puts us in March 2013, suddenly next year’s tax season doesn’t seem so far away. If you really want to get the best tax outcomes in 2013: the time to start planning is now.

2. Uncertainty Looms Over Next Year’s Tax Climate

 

Next year’s tax climate can be best characterized by its extreme uncertainty, which will be brought on by changes resulting from the Supreme Court upholding the Affordable Care Act, as well as by a number of provisions in the Bush tax cuts that are set to expire. This level of uncertainty will make early 2013 a chaotic time for tax planning, and it makes now an even more important time to get the planning process started.

3. You Could Still Benefit from Generous Tax Breaks that May Be Gone Next Year

 

With many provisions of the Bush tax cuts set to expire at year end, starting your 2013 tax planning now means you’ll still have a chance to take advantage of some breaks that may be history by year end. Rates are set to increase on federal income taxes (from 36 percent to 39.6 percent), long-term capital gains (from a maximum tax rate of 15 percent to 20 percent), and dividends (to be taxed as ordinary income). Waiting too long to plan for 2013 may cause you to miss out on some of these tax breaks for good.

4. The Estate Tax Is Set to Increase

 

Significant changes are also set to take place when it comes to the estate tax. This tax is set to increase from 35 percent this year to 45 percent next, and the lifetime exemption amount will go down from $5.12 million to $1 million – unless Congressional action is taken. These changes are likely to impact your plans for 2013, and they make it even more critical that you start the planning process immediately.

5. The Alternative Minimum Tax Will Greatly Expand its Reach

 

Another large tax provision certain to have an impact on many individuals is the higher Alternative Tax Exemption, or AMT patch. This exemption is set to drop from $74,450 this tax year to $45,000 next year. This means that not only will many more people have to pay the AMT patch, but the increase in taxable income will result in even more taxes that individuals pay next year. AMT may not have applied to you in the past, but this year, it may be one of many reasons for you to plan carefully for 2013.

“Regardless of what happens in Congress between now and the end of the year, people can still ensure economic stability for themselves and their future,” said Andrew Lattimer, a partner at BlumShapiro. “But the key is starting now by consulting your tax professionals while there is time to plan without being caught up in what is certain to be a chaotic early 2013.”

 

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