For many individuals, the 2013 federal tax rates on long-term capital gains are the same as last year: either 0% or 15%. However, the maximum rate for higher-income individuals is now 20% (up from 15% last year). This change only affects taxpayers with taxable income above $400,000 for singles, $450,000 for married joint-filing couples, $425,000 for heads of households, and $225,000 for married individuals filing separately. Higher-income individuals can also get hit by the new 3.8% NIIT on net investment income, which can result in a maximum 23.8% federal income tax rate on 2013 long-term gains.
As you evaluate investments held in your taxable brokerage firm accounts, consider the tax impact of selling appreciated securities (currently worth more than you paid for them). For most taxpayers, the federal tax rate on long-term capital gains is still much lower than the rate on short-term gains. Therefore, it often makes sense to hold appreciated securities for at least a year and a day before selling to qualify for the lower long-term gain tax rate.
Biting the bullet and selling some loser securities (currently worth less than you paid for them) before year-end can also be a tax-smart idea. The resulting capital losses will offset capital gains from other sales this year, including high-taxed short-term gains from securities owned for one year or less. For 2013, the maximum rate on short-term gains is 39.6%, and the 3.8% NIIT may also apply, which can result in an effective rate of up to 43.4%. However, you don't need to worry about paying a high rate on short-term gains that can be sheltered with capital losses (you will pay 0% on gains that can be sheltered).
If capital losses for this year exceed capital gains, you will have a net capital loss for 2013. You can use that net capital loss to shelter up to $3,000 of this year's high-taxed ordinary income ($1,500 if you're married and file separately). Any excess net capital loss is carried forward to next year.
Selling enough loser securities to create a bigger net capital loss that exceeds what you can use this year might also make sense. You can carry forward the excess capital loss to 2014 and beyond and use it to shelter both short-term gains and long-term gains recognized in those years. Note that the wash sale rules can limit the deduction for securities losses.
The marriage penalty occurs under the current tax system when a married couple pays more federal income tax when filing jointly than they would if they had remained single and each filed as an individual taxpayer. Historically, Congress has taken steps and passed legislation to provide relief from the marriage penalty. However, the 2010 Affordable Care Act (Affordable Care Act) and the American Taxpayer Relief Act of 2012 (2012 Taxpayer Relief Act) increased the marriage penalty for some high-income couples. Let?s take a look at how this legislation adversely impacts married taxpayers.
The Affordable Care Act brought about the 3.8% net investment income tax (3.8% NIIT) and additional 0.9% Medicare tax. These taxes are sometimes referred to as ?Medicare Taxes.?
The 3.8% NIIT is generally assessed on investment income (interest, dividends, annuities, royalties, rents, and capital gains). The tax is 3.8% of the lesser of net investment income or modified adjusted gross income (MAGI) over an applicable threshold. The thresholds are $250,000 for a married couple filing jointly and $200,000 for a single filer. So a married couple with MAGI of $400,000, all of which is investment income would pay a surtax of 3.8% on $150,000 ($400,000 ? $250,000) or $5,700. If that couple was not married, filed as single taxpayers, and each had $200,000 of income subject to the 3.8% NIIT, they would each have an exclusion of $200,000 available and, therefore, neither would owe this surtax.
The additional 0.9% Medicare tax is assessed on employment and self-employment earnings above the same thresholds. Therefore, a married couple with joint employment earnings of $400,000 would pay the additional 0.9% Medicare tax on $150,000 ($400,000 ? $250,000) or $1,350. Once again, if the individuals were not married, each had $200,000 in earnings, and filed as single taxpayers, they each would have the $200,000 exclusion available and neither would owe the tax. When added to the 3.8% NIIT, that?s a $7,050 ($5,700 + $1,350) marriage penalty resulting from the Affordable Care Act.
The 2012 Taxpayer Relief Act added new 39.6% ordinary income and 20% capital gains rates for some high-income taxpayers. Once again, these new rates potentially increase the marriage penalty. Both rates apply to married couples filing jointly with taxable income above $450,000 and single taxpayers with taxable income above $400,000.
Married individuals with taxable income of $800,000 filing jointly, will pay 39.6% on $350,000 (800,000 ? $450,000) of that income. In contrast, if the couple were not married, had $400,000 of taxable income each, and filed as two single taxpayers, their marginal tax rate (rate on the last dollar of income) would be 35%. So, they would not pay 39.6% on any of their income, but would top out in the 35% bracket. This would make quite a difference in their overall tax bill. In a similar fashion, a married couple filing jointly with $800,000 in long-term capital gains would have $350,000 ($800,000 ? $450,000) subject to the new 20% capital gains rate. Once again, if they were not married with $400,000 each in long-term capital gains and filed as two single taxpayers, the maximum rate on their gains would be 15%.
There you have it. The marriage penalty is alive and well when it comes to high-income taxpayers. Please contact us to discuss the appropriate strategies to reduce your tax bill.
June 2013 Update - Higher Education Costs Continue to Escalate & Help Grandchildren with College Costs
Higher Education Costs Continue to Escalate
The cost of attending college continues to increase. The College Board reports that 2012-2013 tuition and fees have risen significantly (www.collegeboard.org). Private four-year colleges are up 4.2% (to an average of $29,056)from 2011-2012 for tuition and fees. Public four-year colleges are up 4.8% (to an average of $8,655) from last year for in-state tuition and fees. Public four-year colleges are up 4.2% (to an average of $21,706) from last year for out-of-state tuition and fees. Even public two-year schools are up 5.8% (to an average of $3,131). The report indicates that the subsidies provided to full-time undergraduates at public universities through the combination of grant aid and federal tax benefits averaged $5,750 in 2012-2013.
Help Grandchildren with College Costs
Contributing to a Section 529 college savings program is a great way for grandparents to help their grandchildren pay for college. It is also a great way to remove assets from the grandparent's estate without paying estate tax. As an added feature, money in a 529 plan owned by a grandparent is not assessed by the federal financial aid formula when qualifying for student aid.
Grandparents, as well as other taxpayers, have a unique opportunity for gifting to Section 529 college savings plans by contributing up to $70,000 at one time, which currently represents five years of gifts at $14,000 per year. ($14,000 is the annual gift tax exclusion amount for 2013.) A married couple who elects gift-splitting can contribute up to double that amount ($140,000 in 2013) to a beneficiary's 529 plan account(s) with no adverse federal gift tax consequences.
Example: Electing to spread a 529 plan gift over five years.
In 2013, Linda contributes $75,000 to a 529 plan account for the benefit of her grandson, James. She makes no other gifts to James in 2013. Because the gift exceeds the $14,000 annual gift tax exclusion, Linda elects to account for the gift ratably over five years beginning with 2013. Only $70,000 (five times the current annual gift tax exclusion) is eligible for the election; therefore, Linda is treated as having made an excludible gift of $14,000 in years 2013-2017, and a taxable gift of the remainder ($5,000) in 2013.
|May 2013 Update - Tax Breaks for Families and Students & Increased Medicare Payroll Tax|
|Tax Breaks for Families and Students|
Recent legislation made permanent or extended several tax breaks for families. In addition, several education breaks were made permanent or extended.
Child Credit. For 2013 and beyond, the maximum credit for an eligible under-age-17 child (Child Credit) was scheduled to drop from $1,000 to only $500. The legislation permanently installs the $1,000 maximum credit.
Adoption Expenses. The Bush tax cut package included a major liberalization of the adoption tax credit and also established tax-free employer adoption assistance payments. These taxpayer-friendly provisions were scheduled to expire at the end of 2012. The credit would have been halved and limited to only special needs children. Tax-free adoption assistance payments from employers would have disappeared. The legislation permanently extends the more-favorable Bush-era rules.
Education Credit. The American Opportunity Credit, worth up to $2,500, can be claimed for up to four years of undergraduate education and is 40% refundable. It was scheduled to expire at the end of 2012. The legislation extends the American Opportunity Credit through 2017.
College Tuition Deduction. This write-off, which can be as much as $4,000 at lower income levels and as much as $2,000 at higher income levels, expired at the end of 2011. The legislation retroactively restores the deduction for 2012 and extends it through 2013.
Student Loan Interest Deduction. The student loan interest write-off can be as much as $2,500 (whether the taxpayer itemizes or not). Less favorable rules were scheduled to kick in for 2013 and beyond. The legislation permanently extends the more favorable rules that have applied in recent years.
Coverdell Education Savings Accounts. For 2013 and beyond, the maximum contribution to federal-income-tax-free Coverdell college savings accounts was scheduled to drop from $2,000 to only $500, and a stricter phase-out rule would have limited contributions by many married filing joint couples. The legislation makes permanent the favorable rules that have applied in recent years.
Increased Medicare Payroll Tax
The Medicare payroll tax is the primary source of financing for Medicare, which generally pays medical bills for individuals who are 65 or older or disabled. Wages paid through December 31, 2012, were subject to a 2.9% Medicare payroll tax. Workers and employers pay 1.45% each. Self-employed individuals pay both halves of the tax, but are allowed to deduct the employer-equivalent portion (i.e., 1.45%) for income tax purposes. Unlike the social security payroll tax, which applies to earnings up to an annual ceiling ($113,700 for 2013), the Medicare tax is levied on all of an employee's wages subject to FICA taxes.
Beginning in 2013, individuals who have wage and/or self-employment income exceeding $200,000 ($250,000 if married, filing a joint return; $125,000 if married, filing separately) are subject to an additional 0.9% Medicare tax (i.e., 2.35% total) on their earned income exceeding the applicable threshold. The employer portion of the Medicare tax is not increased. However, employers are required to withhold and remit the additional tax for any employee to whom it pays over $200,000. Companies are not responsible for determining whether a worker's combined income with his or her spouse makes the employee subject to the additional tax. Therefore, many individuals (especially those who are married with each earning less than $200,000, but earning more than $250,000 combined) should adjust their federal income tax withholding (FITW) by submitting a new Form W-4 to the employer or make quarterly estimated tax payments to be sure they are not hit with an underpayment penalty when filing their income tax return each year.
Self-employed individuals who pay both halves of the Medicare tax (i.e., 2.9%) will pay a total Medicare tax of 3.8% on earnings above the thresholds. The additional 0.9% tax is not deductible for income tax purposes. Self-employed individuals should adjust their quarterly estimated income tax payments to account for this additional tax.
Married couples with combined incomes approaching $250,000 should keep tabs on their total earnings to avoid an unexpected tax bill when filing their individual income tax return. At this time, the threshold amounts ($200,000/$250,000) are not adjusted for inflation. Therefore, it is likely that increasingly more people will be subject to the higher payroll taxes in coming years.
|March 2013 Update - Overview & Business Provisions of the American Taxpayer Relief Act of 2012|
American Taxpayer Relief Act of 2012
After a great deal of wrangling, Congress passed and the President signed the American Taxpayer Relief Act of 2012 (Act) in early 2013. The Act provides relief for most taxpayers, but will increase the tax bill for high-income folks. The Act includes, among other items, permanent extension of the Bush-era tax cuts for most taxpayers; revised tax rates on ordinary and capital gain income for high-income individuals; modification of the estate tax; permanent fix of the AMT for individual taxpayers; limits on deductions and exemptions of high-income individuals; and numerous retroactively reinstated and extended tax breaks for individuals and businesses. In this article we will discuss several of the Act's provisions impacting individual taxpayers. Business provisions are discussed on page 3.
Tax rates on ordinary income. For tax years beginning after 2012, the 10%, 15%, 25%, 28%, 33%, and 35% tax brackets from the Bush tax cuts will remain in place and are made permanent. This means that, for most Americans, the tax rates on ordinary income will stay the same. However, there will be a new 39.6% rate, which will begin at the following inflation-adjusted thresholds: $400,000 (single), $425,000 (head of household), $450,000 (joint filers and qualifying widows and widowers), and $225,000 (married filing separately).
Estate tax. The new law prevents steep increases in estate, gift, and generation-skipping transfer (GST) taxes that were slated to occur for individuals dying and gifts made after 2012 by permanently keeping the exemption level at $5,000,000 (as indexed for inflation; $5,250,000 in 2013). However, the new law also permanently increases the top estate, gift, and GST rate from 35% to 40%. It also continues the portability feature that allows the estate of the first spouse to die to transfer his or her unused exclusion to the surviving spouse.
Capital gains and qualified dividends rates. The new law retains the 0% tax rate on long-term capital gains and qualified dividends, modifies the 15% rate, and establishes a new 20% rate. Beginning in 2013, the rate will be 0% if ordinary income falls below the 25% tax bracket; 15% if income falls at or above the 25% tax bracket but below the new 39.6% rate; and 20% if income falls in the 39.6% tax bracket. It should be noted that some taxpayers in the 15% and 20% tax brackets could also be required to pay the new 3.8% surtax on investment-type income and gains for tax years beginning after 2012, which applies on investment income of taxpayers with modified adjusted gross income above $250,000 (joint filers), $125,000 (separate), and $200,000 (others).
Personal exemption phase-out. Beginning in 2013, personal exemptions will be phased out (i.e., reduced) for adjusted gross income over $250,000 (single), $275,000 (head of household), and $300,000 (joint filers). Taxpayers claim exemptions for themselves, their spouses and their dependents. For 2013, each exemption is worth $3,900.
Itemized deduction limitation. Beginning in 2013, itemized deductions will be limited for taxpayers with an adjusted gross income over $250,000 (single), $275,000 (head of household), and $300,000 (joint filers).
AMT relief. The new law provides permanent, inflation-adjusted alternative minimum tax (AMT) relief. Prior to the Act, the individual AMT exemption amounts for 2012 were to have been $33,750 for unmarried taxpayers, $45,000 for joint filers, and $22,500 for married persons filing separately. Retroactively effective for tax years beginning after 2011, the new law permanently increases these exemption amounts to $50,600 for unmarried taxpayers, $78,750 for joint filers, and $39,375 for married persons filing separately. In addition, for tax years beginning after 2012, it indexes these exemption amounts for inflation.
Tax credits for low- to middle-wage earners. The new law extends for five years the following items that were originally enacted as part of the 2009 stimulus package and were slated to expire at the end of 2012: (1) the American Opportunity tax credit, which provides up to $2,500 in tax credits for undergraduate college education; (2) eased rules for qualifying for the refundable child credit; and (3) various earned income tax credit (EITC) changes.
Tax break extenders. Many of the "traditional" tax extenders are extended for two years, retroactively to 2012 and through the end of 2013. Among many others, the extended provisions include the election to take an itemized deduction for state and local general sales taxes in lieu of the itemized deduction for state and local income taxes, $250 above-the-line deduction for certain expenses of elementary and secondary school teachers, special rule for contributions made for conservation purposes, above-the-line deduction for qualified tuition and related expenses, and limited tax-free distributions from individual retirement plans for charitable purposes (see page 4).
Payroll tax cut. The 2% payroll tax cut available in 2011 and 2012 was allowed to expire.
Business Provisions of the American Taxpayer Relief Act of 2012
The recently enacted 2012 American Taxpayer Relief Act includes a wide-ranging assortment of tax changes affecting both individuals and businesses. On the business side, two of the most significant changes provide incentives to invest in machinery and equipment by allowing for faster cost recovery of business property. Here are the details.
Enhanced small business expensing (Section 179 expensing). Generally, the cost of property placed in service in a trade or business can't be deducted in the year it's placed in service if the property will be useful beyond the year. Instead, the cost is "capitalized" and depreciation deductions are allowed for most property (other than land), but are spread out over a period of years. However, to help small businesses quickly recover the cost of capital outlays, small business taxpayers can elect to write off these expenditures in the year they are made instead of recovering them through depreciation. The expense election is made available, on a tax-year-by-tax-year basis, under Section 179 of the Internal Revenue Code, and is often referred to as the "Section 179 election" or the "Code Section 179 election." The new law makes three important changes to this expense election.
First, the new law provides that for tax years beginning in 2012 or 2013, a taxpayer will be allowed to write off up to $500,000 of capital expenditures subject to a phase-out (i.e., gradual reduction) once capital expenditures exceed $2 million. For tax years beginning after 2013, the maximum expensing amount will drop to $25,000 and the phase-out level will drop to $200,000.
Second, the new law extends the rule that treats off-the-shelf computer software as qualifying property through 2013.
Finally, the new law extends through 2013 the provision permitting a taxpayer to amend or irrevocably revoke an election for a tax year under IRC Sec. 179 without IRS consent.
Extension of additional first-year depreciation. Businesses are allowed to deduct the cost of capital expenditures over time according to depreciation schedules. In previous legislation, Congress allowed businesses to more rapidly deduct capital expenditures of most new tangible personal property, and certain other new property, by permitting an additional first-year write-off of the cost. For qualified property acquired and placed in service after December 31, 2011, and before January 1, 2013 (before January 1, 2014, for certain longer-lived and transportation property), the additional first-year depreciation was 50% of the cost. The new law extends this additional first-year depreciation for investments placed in service before January 1, 2014 (before January 1, 2015, for certain longer-lived and transportation property).
The new law also extends for one year the election to accelerate the AMT credit instead of claiming additional first-year depreciation for certain corporate taxpayers.
The new law leaves in place the existing rules as to what kinds of property qualify for additional first-year depreciation. Generally, the property must be (1) depreciable property with a recovery period of 20 years or less, (2) water utility property, (3) computer software, or (4) qualified leasehold improvements. Also the original use of the property must commence with the taxpayer-used machinery doesn't qualify.
Please contact us if you would like more information about the new cost recovery provisions or any other aspect of the new legislation.
|April 2013 Update - Residency Issues for Retirees & Home Office Deductions|
|Residency Issues for Retirees|
With 10,000 baby boomers turning 65 each day, some may decide to move to another state for a variety of reasons. These include living in a warmer climate, being closer to children or other relatives, avoiding state income tax, health reasons, or a combination thereof. But, states and municipalities are looking for every available dollar to shore up shrinking budgets. So retirees should use caution to avoid being overtaxed due to a move.
If the retiree's move is intended to be permanent, it is important that legal domicile be established in the new state. If domicile is not established, the retiree may be subject to income tax as a resident of both the old and new states. In addition, since each state has its own rules relating to residence and domicile, both states may try to impose taxes on the retiree even if he or she has established domicile in the new state, but has not adequately relinquished domicile in the previous state.
Furthermore, if the retiree dies without establishing domicile, both the old and the new states may claim jurisdiction over the retiree's estate.
The more time that elapses after the move and the more steps the retiree takes to establish domicile in the new state, the more difficult it will be for the old state to assert that the retiree resides or has domicile there.
The following steps tend to establish domicile in a new state:
For many purposes, the location of property is determined by reference to state law, and legally may be deemed to be somewhere other than where the property is physically located. The state in which the property is deemed to be located may assess income taxes (if any) on income or gains relating to the property. The state may also assess death and succession taxes, and that state will be where probate proceedings will occur when the individual dies. Furthermore, rules of that state will be used to determine whether testamentary instruments are valid and whether the terms of the instruments (such as the powers of a trustee) are legally enforceable.
The retiree's state of domicile generally determines the rules relating to the ownership and tax treatment of intangible personal property. Thus, if the retiree established domicile in a new state, that state's laws generally will apply to his or her intangible assets, such as bank accounts, stocks, bonds, notes, partnership interests, trust income rights, and insurance contracts. Interest income from a savings account, for example, will normally be taxed by the state of domicile, rather than the state in which the account is located.New Simplified Home Office Deduction
The IRS recently announced a simplified option that many owners of home-based businesses and some home-based workers may use to figure their deductions for the business use of their homes. The new optional deduction, capped at $1,500 per year based on $5 a square foot for up to 300 square feet, will reduce the paperwork and recordkeeping burden on small businesses. The new option is available beginning in 2013.
Though homeowners using the new option cannot depreciate the portion of their home used in a trade or business, they can claim allowable mortgage interest, real estate taxes, and casualty losses on the home as itemized deductions on Schedule A, if they choose to itemize their deductions. These deductions need not be allocated between personal and business use, as is required under the regular method.
Business expenses unrelated to the home, such as advertising, supplies, and wages paid to employees, can still be fully deductible. Current restrictions on the home office deduction, such as the requirement that a home office must be used regularly and exclusively for business and the limit tied to the income derived from the particular business, still apply under the new option.
In tax year 2010, the most recent year for which figures are available, the IRS indicates nearly 3.4 million taxpayers claimed deductions for business use of a home. Please contact us if you would like more information on the home office deduction or any other tax compliance or planning issue.