The Unearned Income Medicare Contribution Tax – Part 5

Part 5 of our commentary on Health Care Reform will cover the 3.8 percent Medicare tax slated
to be imposed on the net investment income of high-income taxpayers. The new tax will be
imposed on the interest, dividends, royalties, rents, passive activities, and net gains from sales of property not held in trade or business.

Effective for tax years beginning after December 31, 2012, a 3.8 percent Medicare tax will be
imposed on the lesser of an individual’s net investment income for the tax year or modified AGI
in excess of $200,000 ($250,000 in the case of joint returns and surviving spouses, and $125,000 in the case of a married taxpayer filing separately).

The tax applies to all individuals subject to U.S. taxation other than non-resident aliens. An
estate or trust is also subject to a 3.8 percent tax. Please consult with your tax advisor for the
implications of this if you have an estate or trust.

This means if a single taxpayer made $250,000 and had net investment income of $60,000, they would pay $1,900 for the additional tax. This is comprised of the lesser of:

Wage income calculation:

($250,000 - $200,000) * 3.8% = $1,900

Net investment income calculation:

$60,000 * 3.8% = $2,280

Please consult your tax advisor on how the Unearned Income Medicare Contribution Tax will
impact your tax situation. The IRS website includes a segment of frequently asked questions
related to this topic. You can find that information by following this link:

http://www.irs.gov/uac/Newsroom/Net-Investment-Income-Tax-FAQs

This is a continuation, from Part 4 located here
http://exactcpa.blogspot.com/2013/01/additional-medicare-tax-on-high-income.html

This is a continuation, from Part 3 located here

http://exactcpa.blogspot.com/2013/01/medical-care-itemized-deduction.html

This is a continuation, from Part 2 located here
http://exactcpa.blogspot.com/2012/12/allowable-contributions-to-health.html

Which is a continuation, from Part 1 located here
http://exactcpa.blogspot.com/2012/12/what-does-2013-mean-for-you-in-terms-of.html

More Thoughts on the Fiscal Cliff Deal

By Scott A Hodge for the Tax Foundation: Like everyone in Washington, Tax Foundation staff has been musing over the last-minute deal struck to avoid the full effects of the Fiscal Cliff. Here are some of our thoughts:

It undermines economic growth: On a purely economic level, the deal is a Pyrrhic Victory for America. As our analysis showed, while the deal saved us from going over the Fiscal Cliff, the compromise will undermine long-term economic growth. Moreover, it will lower wages and business investment which means that it will not raise as much new tax revenues as is predicted – about two-thirds less in fact. We find that for every new dollar of revenues that the plan will raise, it will lower GDP by $8.50. That’s a pretty bad deal for the economy.

All taxpayers pay a price: When the tax bill is measured on a purely static basis, it hits only high-income Americans as advertised. However, when we take into account the economic effects on other taxpayers, everyone will suffer lower after-tax incomes as a result – about 1.4% lower incomes for the poor and middle-class. (Our distributional tables here).

The Obama tax code: The deal ends the era of the “Bush Tax Cuts.” The tax code is now President Obama’s and he owns all of its effects, for better or worse.  One good aspect of the deal is that it made most of the tax code permanent (except for the “extenders” of course). One immediate benefit is that we now have certainty over the revenue baseline, which means that there will be a common vocabulary over what is a tax cut and what is a tax increase. We will also have more clarity over what the actual deficit projections are and what is causing them – spending or revenues.

Lots of added complexity: The deal violates almost all of the principles of sound tax policy that we hold dear. The deal reinstated the limitations on personal exemptions and itemized deductions known as the Personal Exemption Phase-Out (PEP) and the Pease provision. The intent of these provisions is to limit write-offs for high-income taxpayers, which is what the Alternative Minimum Tax was also supposed to do.

The deal also adds another tax bracket to the code, increasing the number of brackets to seven from the current level of six. This is a far cry from the two brackets that were in place between 1988 and 1990, and takes us back to the pre-1986 days when there were 15 brackets. The deal also added a third 20 percent bracket to capital gains and dividends (the rates are now 0%, 15%, and 20%). For some high-income taxpayers, the top rates are actually 18.8% and 23.8% when the Obamacare surtax is included.

What about growth? President Obama can declare victory in his effort to make the tax code more progressive. But it is well known that there is a tradeoff between progressivity and economic growth. As our model shows, the tax hike will slow economic growth. So what is going to be done to grow the economy?  Tax reform was to be the vehicle for growing the economy, but... 

A setback for tax reform: The deal is clearly a setback for fundamental tax reform. Since the goal of pro-growth tax reform is to broaden the tax base while lowering tax rates, this will be more difficult to achieve now that the top rate has been boosted to Clinton-era levels and all of the worst elements of the current system (such as refundable tax credits) have been left in place.

So what now? Since it is likely that the new taxes on the rich will fail to provide enough new revenue to make a meaningful dent in the deficit, our guess is that tax reform becomes a vehicle for raising the revenues that Obama and the Democrats failed to get in the Fiscal Cliff deal. The definition for what constitutes “tax reform” will be altered to be about closing loopholes and broadening the tax base, and not about lowering tax rates or wringing the dead-weight losses out of the tax system.

Perhaps we will even begin to see some renewed calls for a carbon tax or Value Added Tax.

Nonpayers: The deal leaves in place all of the various tax credits that have knocked a record 58 million Americans off of the tax rolls. According to the Joint Committee on Taxation estimate of the bill, the refundable "outlay effects" of the various measures in the bill (such as the Earned Income Credit, Child Credit, American Opportunity Credit) total $276.5 billion over the next ten years.

Including the non-filers, roughly half of all households pay no income taxes and many of these households benefit from the more than $100 billion in refundable credits that are currently dispensed each year by the IRS to those who own no income taxes. The nonpayer issue will remain a serious problem for years to come.

Inequality: Despite the boost in top tax rates, inequality will continue to grow in America. That is because the tax system has little to do with the current level of inequality. Disparities in educational attainment are having a much bigger effect on inequality and the higher tax rates will not substantially reduce the economic returns from higher education. Our question is, what will the White House say when their tax increase fails to stem the rise in inequality? Our guess is that issue of inequality falls off the radar screen for the next couple of years.

Corporate tax reform: We’re not sure how the deal effects the movement corporate tax reform. Nothing in the deal changes the fact that the U.S. has the highest corporate tax rate in the industrialized world and has an obsolete “worldwide” corporate tax system that is undermining American competitiveness. The deal does, however, create a disparity in the marginal rates in which business forms are taxed. While we are big proponents of cutting the corporate tax rate, we worry about having too big of a disparity between the rates paid by corporate and non-corporate businesses.  We certainly don’t need to be reminded of the double-tax on corporate income, but we still think it would be a problem if the tax rate for S-corporations and LLCs was stuck at 39.6%, while the rate for multi-national C-corporations was lowered to say 28% as some have suggested.

ExactCPA Commentary
There has been tons of fanfare surrounding the passing of legislation to avoid the fiscal cliff.  Most of the country has noted how imperative it is to pass legislature to not raise taxes in order to keep the economy on track.  Mr. Hodge provides a different perspective on what the fiscal cliff will mean for our country.  As noted in his article above, his view is that averting the fiscal cliff will actually hurt our economy in the long run through factors such as lower wages and lower business investment.

A couple of points that were interesting to note were his comments on non-paying taxpayers and the continued economic inequity in America.  Many of the refundable tax credits that have been kept in place by the American Taxpayer Relief Act will be helpful to working families (yeah!) but at the same time allow an additional 58 million taxpayers to be free from paying taxes.  What will we do in future years to raise revenue?  Could be an interesting dilemma in the years ahead.  Mr. Hodge also gives some discussion surrounding the economic inequity discussion.  Mr. Hodge maintains that our tax system has little to do with the state of the tax system in America, and for what it's worth, I must say that I agree.  Like Mr. Hodge, I believe we should look at the education gap in order to assist in resolving some of these economic issues.  

This article provided some interesting perspectives as to the outcome of the fiscal cliff saga and its effect on the economy.  I look forward to hearing more of what he has to say.  Have a great day!

As always if you have questions, please feel free to reach out to us at questions@exactcpa.com.

2012 American Taxpayer Relief Act - Overview To Our Clients

After weeks, indeed months of proposals and counter-proposals, seemingly endless negotiations and down-to-the-wire drama, Congress has passed legislation to avert the tax side of the so-called “fiscal cliff.” The American Taxpayer Relief Act permanently extends the Bush-era tax cuts for lower and moderate income taxpayers, permanently “patches” the alternative minimum tax (AMT), provides for a permanent 40 percent federal estate tax rate, renews many individual, business and energy tax extenders, and more. In one immediately noticeable effect, the American Taxpayer Relief Act does not extend the 2012 employee-side payroll tax holiday.

The American Taxpayer Relief Act is intended to bring some certainty to the Tax Code. At the same time, it sets stage for comprehensive tax reform, possibly in 2013. Moreover, it creates important planning opportunities for taxpayers, which we can discuss in detail.

Individuals

Unlike the two-year extension of the Bush-era tax cuts enacted in 2010, the debate in 2012 took place in a very different political and economic climate. If Congress did nothing, tax rates were scheduled to increase for all taxpayers at all income levels after 2012.  President Obama made it clear that he would veto any bill that extended the Bush-era tax cuts for higher income individuals. The President’s veto threat gained weight after his re-election.  Both the White House and the GOP realized that going over the fiscal cliff would jeopardize the economic recovery, and the American Taxpayer Relief Act is, for the moment, their best compromise.

Tax rates.  The American Taxpayer Relief Act extends permanently the Bush-era income tax rates for all taxpayers except for taxpayers with taxable income above certain thresholds:

$400,000 for single individuals, $450,000 for married couples filing joint returns, and $425,000 for heads of households.  For 2013 and beyond, the federal income tax rates are 10, 15, 25, 28, 33, 35, and 39.6 percent.  In comparison, the top rate before 2013 was 35 percent.  The IRS is expected to issue revised income tax withholding tables to reflect the 2013 rates as quickly as possible and provide guidance to employers and self-employed individuals.

Additionally, the new law revives the Pease limitation on itemized deductions and personal exemption phaseout (PEP) after 2012 for higher income individuals but at revised thresholds. The new thresholds for being subject to both the Pease limitation and PEP after 2012 are $300,000 for married couples and surviving spouses, $275,000 for heads of households, $250,000 for unmarried taxpayers; and $150,000 for married couples filing separate returns.

Capital gains.  The taxpayer-friendly Bush-era capital gains and dividend tax rates are modified by the American Taxpayer Relief Act. Generally, the new law increases the top rate for qualified capital gains and dividends to 20 percent (the Bush-era top rate was 15 percent). The 20 percent rate will apply to the extent that a taxpayer’s income exceeds the $400,000/$425,000/$450,000 thresholds discussed above. The 15 percent Bush-era tax rate will continue to apply to all other taxpayers (in some cases zero percent for qualified taxpayers within the 15-percent-or-lower income tax bracket).

Payroll tax cut.  The employee-side payroll tax holiday is not extended. Before 2013, the employee-share of OASDI taxes was reduced by two percentage points from 6.2 percent to 4.2 percent up the Social Security wage base (with a similar tax break for self-employed individuals).  For 2013, two percent reduction is no longer available and the employee-share of OASDI taxes reverts to 6.2 percent. The employer-share of OASDI taxes remains at 6.2 percent. In 2012, the payroll tax holiday could save a taxpayer up to $2,202 (taxpayers earning at or above the Social Security wage base for 2012).  As a result of the expiration of the payroll tax holiday, everyone who receives a paycheck or self-employment income will see an increase in taxes in 2013.

AMT. In recent years, Congress routinely “patched” the AMT to prevent its encroachment on middle income taxpayers. The American Taxpayer Relief Act patches permanently the AMT by giving taxpayers higher exemption amounts and other targeted relief. This relief is available beginning in 2012 and going forward. The permanent patch is expected to provide some certainty to planning for the AMT. No single factor automatically triggers AMT liability but some common factors are itemized deductions for state and local income taxes; itemized deductions for miscellaneous expenditures, itemized deductions on home equity loan interest (not including interest on a loan to build, buy or improve a residence); and changes in income from installment sales. Our office can help you gauge if you may be liable for the AMT in 2013 or future years.

Child tax credit and related incentives.  The popular $1,000 child tax credit was scheduled to revert to $500 per qualifying child after 2012.  Additional enhancements to the child tax credit also were scheduled to expire after 2012.  The American Taxpayer Relief Act makes permanent the $1,000 child tax credit. Most of the Bush-era enhancements are also made permanent or extended. Along with the child tax credit, the new law makes permanent the enhanced adoption credit/and income exclusion; the enhanced child and dependent care credit and the Bush-era credit for employer-provided child care facilities and services.

Education incentives.  A number of popular education tax incentives are extended or made permanent by the American Taxpayer Relief Act.  The American Opportunity Tax Credit (an enhanced version of the Hope education credit) is extended through 2017.  Enhancements to Coverdell education savings accounts, such as the $2,000 maximum contribution, are made permanent.  The student loan interest deduction is made more attractive by the permanent suspension of its 60-month rules (which had been scheduled to return after 2012). The new law also extends permanently the exclusion from income and employment taxes of employer-provided education assistance up to $5,250 and the exclusion from income for certain military scholarship programs.  Additionally, the above-the-line higher education tuition deduction is extended through 2013 as is the teachers’ classroom expense deduction.

Charitable giving.  Congress has long used the tax laws to encourage charitable giving.  The American Taxpayer Relief Act extends a popular charitable giving incentive through 2013:  tax-free IRA distributions to charity by individuals age 70 ½ and older up to maximum of $100,000 for qualified taxpayer per year.  A special transition rule allows individuals to recharacterize distributions made in January 2013 as made on December 31, 2012.  The new law also extends for businesses the enhanced deduction for charitable contributions of food inventory.

Federal estate tax.  Few issues have complicated family wealth planning in recent years as has the federal estate tax.  Recent laws have changed the maximum estate tax rate multiple times. Most recently, the 2010 Taxpayer Relief Act set the maximum estate tax rate at 35 percent with an inflation-adjusted exclusion of $5 million for estates of decedents dying before 2013. Effective January 1, 2013, the maximum federal estate tax will rise to 40 percent, but will continue to apply an inflation-adjusted exclusion of $5 million. The new law also makes permanent portability between spouses and some Bush-era technical enhancements to the estate tax.

Businesses

The business tax incentives in the new law, while not receiving as much press as the individual tax provisions, are valuable. Two very popular incentives, bonus depreciation and small business expensing, are extended as are many business tax “extenders.”

Bonus depreciation/small business expensing.  The new law renews 50 percent bonus depreciation through 2013 (2014 in the case of certain longer period production property and transportation property). Code Sec. 179 small business expensing is also extended through 2013 with a generous $500,000 expensing allowance and a $2 million investment limit.  Without the new law, the expensing allowance was scheduled to plummet to $25,000 with a $200,000 investment limit.

Small business stock.  To encourage investment in small businesses, the tax laws in recent years have allowed noncorporate taxpayers to exclude a percentage of the gain realized from the sale or exchange of small business stock held for more than five years.  The American Taxpayer Relief Act extends the 100 percent exclusion from the sale or exchange of small business stock through 2013.

Tax extenders.  A host of business tax incentives are extended through 2013.  These include:

Research tax credit

Work Opportunity Tax Credit

New Markets Tax Credit

Employer wage credit for military reservists

Tax incentives for empowerment zones

Indian employment credit

Railroad track maintenance credit

Subpart F exceptions for active financing income

Look through rules for related controlled foreign corporation payments

Energy

For individuals and businesses, the new law extends some energy tax incentives.  The Code Sec. 25C, which rewards homeowners who make energy efficient improvements, with a tax credit is extended through 2013.  Businesses benefit from the extension of the Code Sec. 45 production tax credit for wind energy, credits for biofuels, credits for energy-efficient appliances, and many more.

Looking ahead

The negotiations and passage of the new law are likely a dress rehearsal for comprehensive tax reform during President Obama’s second term.  Both the President and the GOP have called for making the Tax Code more simple and fair for individuals and businesses.  The many proposals for tax reform include consolidation of the current individual income tax brackets, repeal of the AMT, moving the U.S. from a worldwide to territorial system of taxation, and a reduction in the corporate tax rate. Congress and the Obama administration also must tackle sequestration, which the American Taxpayer Relief Act delayed for two months. All this and more is expected to keep federal tax policy in the news in 2013. Our office will keep you posted of developments.

If you have any questions about the American Taxpayer Relief Act, please contact our office. We can schedule an appointment to discuss how the changes in the new law may be able to maximize your tax savings.

Thank You, ExactCPA

IRS Proposes Regulations Creating Truncated Taxpayer ID Number

The IRS has proposed regulations creating a new taxpayer identification number, which would be known as a truncated taxpayer identification number, or TTIN. This number would be available as an alternative to the Social Security number, the IRS individual taxpayer identification number, or the IRS adoption taxpayer identification number for use by the filer of certain information returns to identify the person being furnished a statement. The TTIN displays only the last four digits of an individual’s identifying number and is shown in the format XXX-XX-1234 or ***-**-1234.

Code Sec. 6109 authorizes the IRS to require the inclusion of an identifying number in returns, statements, or other documents as a means of securing proper identification of the filer. The IRS announced a pilot program in Notice 2009-93, I.R.B. 2009-51, 863, extended and modified inNotice 2011-38, I.R.B. 2011-20, 785, which authorized filers of certain information returns to truncate an individual payee’s nine-digit identifying number on specified paper payee statements furnished for 2009 through 2012. The proposed regulations would implement this program, which was conceived in response to concerns about the risk of identity theft. The risk of misappropriation and subsequent misuse of identification numbers has been reported to be a significant problem with paper payee statements.

Commonly used payee statements for which paper copies are issued include Forms 1098 (Mortgage Interest Statement), 1099-MISC (Miscellaneous Income), 1099-R (Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRS, Insurance Contracts, Etc.), 1099-S (Proceeds from Real Estate Transactions), 1099-C (Cancellation of Debt) and 1098-T (Tuition Statement). The TTIN would not be used on Form W-2 (Wage and Tax Statement), which requires the employee’s name and Social Security number, nor is truncation possible for any number assigned to taxpayers other than individuals, such as an employer identification number.

The TTIN may be used only on payee statements, whether furnished by paper or electronic means. Its use is optional. A filer may not use a TTIN on an information return filed with the IRS, nor may a filer truncate its own identifying number of information returns or payee statements. Notice 2011-38 will be obsolete on the date these proposed regulations become final.

Proposed Regulations, NPRM REG-148873-09, 2013FED ¶49,558

Tax Planning for 2013 Just Got Trickier

By Arden Dale at arden.dale@dowjones.com  (Wall St. Journal) For wealthy taxpayers, two things are certain in 2013: They'll pay more in taxes and face a more complicated tax-planning regime.  Under the fiscal-cliff deal stuck this week, the wealthy and their financial advisers now will have to navigate more rules than ever. The law ties key tax rates to a new level of wealth, and sets separate income thresholds to limit deductions for the rich and to levy a new investment tax."There are more parts now," said economist Roberton Williams of the Tax Policy Center, a nonpartisan group in Washington, D.C. Already, some advisers say they plan to be more active throughout the year in helping their clients manage when to take income and deductions. At Pittsburgh advisory firm Waldron Wealth Management, for example, advisers will redouble efforts to spot the best times to take capital gains or losses and make charitable deductions, said Michael Krol, a financial planner at the firm.

"It becomes all the more important," said Mr. Krol, who will weigh other details, too. These include, given new limits on deductions, whether it makes more sense for a client to take the mortgage interest deduction or pay off the mortgage with a loan and deduct the loan interest.

James H. Guarino, an accountant and certified financial planner at MFA--Moody, Famiglietti & Andronico LLP in Tewksbury, Mass., said it's now critical that individuals be able to estimate their taxable income before the end of the calendar year to do strategic tax planning.

The most basic change advisers face is the definition of who is wealthy. The top brackets for income, capital gains and dividend taxes now kick in at a new income threshold--$400,000 ($450,000 for joint filers) of taxable income. But a new 3.8% Medicare surtax on investment income, including capital gains and dividends, applies to individuals with an adjusted gross incomes of $200,000 ($250,000 for joint filers).

The two sets of thresholds mean some wealthy clients will be subject to the surtax on investments, while others are not. And, because the surtax--mandated under the Affordable Care Act--isn't indexed to inflation, it will apply to more people each year.

Deductions, too, are now more complicated. After a hiatus of two years, rules to limit tax write-offs by the rich are in effect again. Three income thresholds apply to these limits, known as the Personal Exemption Phaseout (PEP) and the Limitation on Itemized Deductions (Pease): $250,000 of adjusted gross income for individuals, $275,000 for heads of households, and $300,000 for joint returns.

In the midst of all the change, a few things will stay the same, and make life easier. The estate tax exemption, set at $5 million last year after a series of changes over the past decade, will remain the same. The alternative minimum tax is now tied to inflation, eliminating last-minute battles to keep it from applying to millions more people.

Sorting it all out will take a while. Like many others, Laura Sundquist, a certified public accountant with Sage Financial Design Inc. in Simsbury, Conn., is wading through the details.

"I like to get my tax letter out to clients in the first week of January but that may not happen because I have to understand it first," she said.

Fiscal Cliff New Tax Law: Businesses That Came Out Winning Big

It helps to have a lobbyist in Washington DC serving your agenda...take a look at some of the industries who stand to benefit from tax credits and other provisions in the new law:

An exemption that allows banks, insurance companies and other financial firms to shield foreign profits from being taxed by the U.S. The tax break is important to major multinational banks and financial firms. Cost: $11.2 billion.

A tax break that allows profitable companies to write off large capital expenditures immediately - rather than over time - giving some companies huge tax shelters. The tax break, known as bonus depreciation, benefits automakers, utilities and heavy equipment makers. Cost: $5 billion.

A tax credit for the production of wind, solar and other renewable energy. Cost: $12.2 billion.

A provision that allows restaurants and retail stores to more quickly write off the cost of improvements. Cost: $3.7 billion.

Increased tax rebates to Puerto Rico and the Virgin Islands from a tax on rum imported into the United States. The U.S. imposes a $13.50 per proof-gallon tax on imported rum, and sends most of the proceeds to the two U.S. territories. Cost: $222 million.

A 50% tax credit for expenses related to railroad track maintenance through 2013. Cost $331 million.

A provision that allows motorsport race tracks to more quickly write off improvement costs. Cost: $78 million.

Enhanced deductions for companies that donate food to the needy, books to public schools or computers to public libraries. Cost: $314 million.

A tax break that allows TV and movie productions to more quickly write off expenses. Sexually explicit productions are ineligible. Cost: $248 million.

A tax credit of up to $2,500 for buying electric-powered vehicles was expanded to include electric-powered motorcycles. Golf carts, however, were excluded. Cost: $7 million.