December 2013 Tax Planning Update
We would like share with you some information that we received while attending a recent educational seminar. The seminar, sponsored by the American Institute of CPA’s, was titled Sophisticated Tax Planning for Wealthy Clients. However, the title is somewhat of a misnomer, as the speakers touched on many areas that concern us all, not just those in the upper brackets. It is true, however, that the upper brackets will be impacted the most by the changes in tax law taking effect in 2013 and beyond.
The items of most interest to the majority of you include:
Law changes this year including expiring provisions.
Health care rules that will impact small business.
Issues of concern in the estate tax area even if there is not taxable federal estate.
Medicare tax on investment income.
Issues related to domestic help.
Current IRS audit issues.
What to do now to minimize taxes
Tax Law Changes and Expiring Provisions
This tax season will be the first impacted by the American Taxpayer Relief Act, which was passed in early January and was the primary cause of the most difficult tax filing season ever. Unfortunately, taxpayer relief will be a misnomer for most taxpayers.
The good news: the so-called Bush tax cuts were extended, continuing the lower rates for most.
The bad news: we now have several definitions of “rich.” For some provisions, $200K single and $250K married filing joint ($125K if married filing separate) makes the grade. This cut off relates to the new Medicare tax provisions (0.9% on earned income and 3.8% on net investment income). However, for the new phase out of itemized deductions and personal exemptions, which reduce the tax benefit you receive from itemized deductions and personal exemptions once you pass the threshold, the breakpoints are $250K for single and $300K for married filing joint returns. And just for good measure, to hit the new 39.6% bracket and the new 20% tax rate on capital gains, the thresholds are $400K single and $450K married filing joint.
If you get the sense this law is becoming far too complex, wait for the rules related to the Affordable Care Act.
Looking forward to next year, other provisions that are expiring after 2013 include:
The option to deduct sales tax instead of state income tax. While this is not a significant issue in Massachusetts, it can be for taxpayers in states that do not have an income tax.
The deduction for tuition, previously available as an alternative to the education credits
Home energy credits.
The above-the-line deduction for teachers’ expenses
The ability to make charitable contributions direct from your IRA.
In summary, most of our clients are likely to have an unpleasant day on April 15, 2014 as the withholding and estimate payments based upon last year’s tax probably will not be enough to offset the increases.
Health Care Rules Impacting Small Businesses
As to the Affordable Care Act, we previously sent out a mailing on the increased Medicare Taxes. The fun keeps coming, although much of it will be delayed to 2015. The details are overwhelming, but here are a few key points on items impacting this year’s returns, and requirements that kick off after January 1st:
For 2013 returns, the medical deduction threshold jumps from 7% of your adjusted gross income (AGI) to 10%. While it was already difficult to meet the 7% threshold, tallying up your CVS receipts may become more trouble than it’s worth when the total must exceed 10% of AGI to receive any benefit
The individual mandate penalty will be due in April for those who are uninsured. The good news for those impacted is that the IRS is charged with collecting this tax, but can only take it from your refund, and have no additional collection weapons if they are not already holding your money. Businesses will have added burdens, but it appears that the one year deferral of the business mandate has delayed the impact.
Most of us we have what are referred to as fully-insured plans, which means we buy insurance and do not self-insure. Accordingly, the bulk of the added taxes such as the $63 per participant fee, the excise tax on insurance policies, and the so-called tax on “Cadillac plans” (starts in 2018) will be paid by the insurance company. However, it is highly unlikely they will do so for free, so expect to see these added costs folded into your premiums.
Be aware that the ability for small employers to discriminate regarding who gets what health coverage is going away. Rules similar to the rules on retirement plans will be in effect for health insurance.
Estate Tax Concerns
On the estate tax front, the $5 million exemption may dissuade the executor of an estate from filing an estate tax return. However, if a return is not filed, two important tax savings may be lost. First, there is portability between spouses; meaning that if the first to die does not use all of their $5 million exemption, the unused portion can be “ported” to the surviving spouse. This gives a potential exemption of $10 million, but the election to transfer the excess must be made on the estate tax return of the first to die. The general consensus is that, if no return is filed, the portability is lost. This may seem unimportant, but consider the impact if the surviving spouse’s estate grows. Perhaps they win the lottery, or have a stroke of good fortune on an investment, or see a significant inflation of value in the family home? If the porting election is not made, heirs to the surviving spouse’s estate may end up kicking themselves further down the road.
A second factor is that assets transferred through an estate receive an increase in the tax cost (basis) used to compute gain when the asset is sold. The estate tax return provides the documentation if the heir gets examined.
Keep in mind that state laws vary. For instance, Massachusetts’ estate tax exemption is only $1 million. So even if you do not meet the Federal threshold, there may be filing requirements and potential tax liabilities at the state level. Also remember that the traditional estate documents like wills, durable powers of attorney, and health care proxies are still needed, as well as potential probate issues.
3.8% and 0.09% Medicare Taxes
We discussed the new 3.8% tax on net investment income and 0.9% tax on earned income in our last newsletter (available here if you didn’t receive it or would like a refresher, http://www.krupsky.net/2013/07/affordable-care-act/). The issues surrounding these taxes are complex, and the IRS recently released final regulations on the matter, so the landscape continues to shift. We will keep you updated as any changes unfold. As always, feel free to contact us to discuss your specific situation and how these taxes might impact you.
The issue of domestic workers has been on the forefront since Zoe Biard’s nomination during the Clinton administration. It has now reached a critical point as the Department of Labor has stepped into the fray. Although most of you are thinking, “I don’t have any domestic employees, why should I worry?” consider this: If you pay someone more than $1,800 in a year to work in your home, they are a domestic employee, and cannot be treated as an independent contractor or business employee. The detailed implications are beyond the scope of this letter, but if you think it might apply to you, please contact us to evaluate your specific case.
Current IRS Audit Issues
The IRS selection process is always a mystery and a subject of conversation and concern. The consensus from IRS data and tax practitioner input lists the following areas as hot buttons right now:
Mortgage interest deductions that appear to exceed the $1.1 million limits
Foreign bank accounts and failure to report them.
Sales of real estate.
Tax free exchanges under IRC §1031.
Self-employed individuals, with special attention to cash oriented business.
The perennial favorite: non-filers.
The best defense, whether you fall into the above-noted areas or not, is to keep good records.
Tax Planning Strategies for Year-End
As we approach the end of the year, now is the time to make planning decisions and take steps to control your tax liability. Once the calendar flips on January 1st, it will be too late.
Tax planning considerations have returned to more traditional matters this year, in comparison with last year when last year we had no idea what tax rates would be in 2013. Things to consider include deferring income and accelerating deductible expenses. This applies particularly to cash-basis business taxpayers. Also think about capital gains and losses: Have you already recognized some gains? If so, maybe you have some loss positions that you might consider closing out against those gains.
Are you eligible for a deductible IRA? Contributions must be deposited by April 15, 2014. On a similar note, if you are self-employed, a SEP may be a good move. You have until the due date of the return, including extension, to pay in the contribution. Did you pay health insurance premiums for your employees? You may qualify for the health insurance credit. (However, don’t get too excited, as the wage limitations work well in rural areas with a lower wage scale than Massachusetts.)
While removing funds from a traditional IRA, paying the tax now, and funding a ROTH IRA is generally not something we would recommend, it can make sense under the right circumstances.
For businesses, the rules regarding the election to expense assets in the year of purchase are drastically reduced after 2013. The allowable deduction for 2014 drops from $500K to $25K. However, be careful in 2013 not to bulk up on asset purchases unless you have enough income to fully utilize these deductions. While amounts in excess of income have carried over to the following year in the past, this will not be the case rolling from this year into next.
This letter is not intended as an all-encompassing summary, so please contact us regarding your specific tax issues. We will be forwarding your tax organizers to you in late December.
If you would prefer to receive your organizer via e-mail, please go to http://organizer.krupsky.net and add your e-mail address to our electronic organizer list.