Protecting Your Wealth From Estate And Income Tax Changes

Dustin Stamper for Grant Thornton writes: Large tax increases are scheduled to take effect in 2013 unless Congress acts – threatening to drastically alter both transfer tax and income tax rules. High net worth taxpayers face the prospect of new taxes on both their income and their estates, but also an opportunity. You may have begun considering whether 2012 is the year to reverse your income tax strategy and accelerate income and defer deductions, and whether it's time to put transfer tax strategies into play while interest rates are low and transfer tax rules are favorable.

The November election and political gridlock have made the outlook for legislation uncertain. This makes tax planning not only difficult but also more important. The decisions you make now may have a tremendous impact on your tax obligations in the future. The tax increases are scheduled to come from various sources: new Medicare taxes, the expiration of the 2001 and 2003 income tax cuts, and the expiration of the estate and gift tax rules enacted in 2010.

Strategies to accelerate income tax should be approached very cautiously. Transfer tax strategies during legislative uncertainty also carry risks. First, you need to understand exactly which taxes are scheduled to increase and by how much, and how those increases would actually affect you. You also need to understand the likelihood that these tax increases will actually occur. That's why it is prudent to prepare now but wait to act until the legislative outlook becomes clearer. This Tax Insights will help by:

• explaining the scheduled estate and income tax increases in detail and examining the potential for legislation to defer or prevent them,
• discussing how to approach income and transfer tax planning in this environment, and
• discussing the specific tax issues and planning ideas that need to be addressed.

What's really coming?

Tax increases on income

Both payroll and income taxes are scheduled to increase starting on Jan. 1, 2013. Without legislative action, the 2001 and 2003 tax cuts will expire and new Medicare taxes enacted as part of the health care reform legislation in 2010 will take effect. The expiration of the 2001 and 2003 tax cuts would erase scores of benefits, including:

• rate cuts across all income brackets,
• the full repeal of the personal exemption phaseout (PEP) and "Pease" phaseout of itemized deductions,
• the top rate of 15% for capital gains and dividends,
• the zero rate for capital gains and dividends in the bottom brackets,
• marriage penalty relief and the $1,000 refundable child tax credit,
• the increased dependent care credit and the employer credit for child care facilities,
• the $12,650 adoption credit and the $12,650 income exclusion for employer adoption assistance, and
• several education related incentives.

The loss of rate cuts is the most significant threat (see chart). Because the tax increases come on the individual side, they will affect both your individual income and any business income from privately held and pass-through businesses taxed at the individual level. And on top of these tax increases comes the new Medicare taxes.

Individual income tax rates*
Ordinary income tax brackets (2012 levels)			Rates
Single	Joint		2012		2013 +
$0–$8,700	$0–$17,400		10%		15%
$8,701–$35,350	$17,401–$70,700		15%		15%
$35,351–$85,650	$70,701–$142,700		25%		28%
$85,651–$178,650	$142,701–$217,450		28%		31%
$178,651–$388,350	$217,451–$388,350		33%		36%
Over $388,350	Over $388,350		35%		39.6%
Capital gains top rate		15%		20%
Dividend top rate		15%		39.6%
* Does not include Medicare taxes. Top capital gains rate in 2013 will be 20% for assets held more than a year and 18% for assets held more than five years, not including the 3.8% Medicare tax.

First, the rate of the individual share of Medicare tax will increase from 1.45% to 2.35% on earned income above $200,000 for single filers and $250,000 for joint filers. The 1.45% employer share will not change, creating a top rate of 3.8% on self-employment income. In addition, investment income such as capital gains, dividends and interest will be subject for the first time to a new 3.8% Medicare tax to the extent AGI exceeds $200,000 (single) or $250,000 (joint). There is no cap on Medicare taxes.

Individual Medicare tax rates*
Earned income (salary, self-employment)		2012		2013 +
$0–$200k (single)	$0–$250k (joint)		1.45%		1.45%
$200k + (single)	$250k + (joint)		1.45%		2.35%
Investment income (dividends, cap gains, interest)		2012		2013 +
$0–$200k (single)	$0–$250k (joint)		0%		0%
$200k + (single)	$250k + (joint)		0%		3.8%
*Does not include 1.45% employer share on earned income, which also applies to self-employment income and will not change.

The new tax on investment income will not apply to distributions from qualified retirement plans or active trade or business income. Active S corporation income not paid as salary will still not incur Medicare tax, as it is not earned income.

A two-year partial payroll tax holiday, which cut the individual share of Social Security tax from 6.2 percent to 4.2 percent, is also scheduled to expire at the end of the year, but Social Security taxes are capped annually ($110,100 in 2012).

The combined tax increases would severely affect top rates on all types of income. The top rates on dividends, interest and earned income (see chart) would apply when income reached the top tax bracket ($388,350 in 2012), though the Medicare portion would apply at the $200,000 or $250,000 thresholds. The top rate of 23.8% rate on capital gains would be reached at $200,000 or $250,000 thresholds.

Combined top rates*
Type of income	2012	2013 +
Earned income	36.45%	41.95%
Interest	35%	43.4%
Dividends	15%	43.4%
Capital gains	15%	23.8%
*Includes only employee share of Medicare taxes

Tax increases on wealth transfers

The good news is that the transfer tax rates through the end of 2012 are at historic lows, and exemption levels are at historic highs. The bad news is that these rules are scheduled to change at the end of the year. The current rules (agreed to in 2010 as part of an extension of the 2001 and 2003 tax cuts) generally reunite the estate and gift taxes with the following rules:

• 35% rate
• $5.12 million exemption
• Portability of estate tax exemption amounts between spouses

If no legislation is enacted, the estate, gift and generation-skipping transfer (GST) taxes will all revert to the rules in place in 2000, with a top rate of 55 percent and an exemption of just $1 million (see chart).

Exemptions and rates for estate, gift, and GST
2012		2013 +
Exemption	$5.12 million		$1 million
Rate	35%		55%

Potential for legislation

Congress has so far made little progress. Both parties held votes on separate plans to extend the 2001 and 2003 tax cuts before adjourning for the August recess, but these votes were largely vehicles to stake out campaign positions. No legislation is expected until after the elections, when lawmakers are likely to return in November to work on a lame duck compromise. In a similar process in 2010, the president agreed to extend the 2001 and 2003 tax cuts for two years, but an agreement may be more difficult this year.

The bills voted on by Democrats and Republicans would both extend the tax cuts for one year, except the Democratic bill would allow the tax cuts to expire for income above certain thresholds ($200,000 minus the standard deduction and a personal exemption for singles and $250,000 minus the standard deduction and two personal exemptions for joint filers). Capital gains and dividends above these thresholds would be subject to a top rateof 20%, and PEP and Pease would be reinstated with phase-ins beginning at these thresholds.

Regarding transfer taxes, Senate Democrats initially included a provision applying the rules in place in 2009 to 2013 ($3.5 million exemptions and a top rate of 45%), but backed away after several moderate Democrats in relatively conservative states said they may not support such a reversion. House Republicans proposed to extend the current transfer tax rules through 2013.

Despite their political nature, the votes do offer insight into the outlook for eventual legislation. For one, lawmakers appear to have settled on an extension for just one year. A one-year extension is meant to give lawmakers time and leverage for a potential tax reform effort in 2013.

The votes also reveal that congressional Democrats are committed to campaigning on a promise to roll back the tax cuts above the $200,000 and $250,000 thresholds, although there may be room for negotiation in a lame duck session. Several Democratic lawmakers had previously floated the idea of extending the 2001 and 2003 tax cuts on income up to $1 million. It is also clear that Democrats are far from unified on transfer taxes. This may give Republicans a slight advantage on the issue.

It is difficult to predict a final outcome. The results of the election will have an impact, but a bipartisan compromise will still be necessary. If President Obama is re-elected, he will need to negotiate with Republicans in Congress. If Republicans take both chambers and the White House, they will likely need to negotiate with Democrats in the Senate to overcome procedural hurdles. President Obama agreed to an extension of all the tax cuts in 2010, but is now facing a more dire debt situation and has been more rigid in his calls for additional revenue. The extension of most of the 2001 and 2003 tax cuts remains likely, but the outcome for the tax cuts at high income levels and for transfer tax rules is uncertain. The repeal of the new Medicare tax may be an uphill battle, given the current condition of the Medicare trust fund and the political sensitivity of the issue.

Considerations for your 2012 tax strategy

Income taxes and payroll taxes

With the clear potential for tax increases, taxpayers may be tempted to accelerate tax into 2012 by deferring deductions and recognizing income. But a careful analysis of several factors should come first, and there are many reasons why accelerating tax is a bad idea.

First, determine whether the tax increases will apply to you. Tax increases are unlikely to affect any income below the income thresholds of $200,000 (single) or $250,000 (joint), and it's possible taxes won't increase at all. Accelerating tax in 2010 provided little or no benefit when the tax cuts were extended. That's why it will be prudent to prepare now but act only when the legislative outlook becomes clearer.

If you're subject to the alternative minimum tax, you may not benefit from any acceleration in tax. In addition, remember you may be in a lower tax bracket at retirement. You also need to consider transfer tax consequences. Triggering gain can backfire if an asset otherwise would have received a step up in basis at death.

You also need to consider the actual rate change versus the time value of money. The tax increases would affect many types of income in many different ways. When thinking about accelerating tax, it will be important to understand exactly how much tax would be paid in the future and how long you otherwise could have deferred the tax. Even at today's low interest rates, the time value of money will still make deferral the best strategy in many situations. You probably do not want to trigger gain on property you would otherwise have held onto for years just to avoid a capital gain rate increase from 15% to 20%. Economic considerations should always come before any tax-motivated sale.

Transfer taxes

Transfer taxes are a different story. Given the legislative uncertainty and the current economic conditions, 2012 may provide a unique window for estate and gift tax planning. Interest rates are at historic lows, and values of property and other assets have declined because of past economic conditions, which now appear to be improving. When both of these conditions exist, property transfer is almost always beneficial, even if gift tax is incurred.

Specific issues and planning ideas that need to be considered

Income and payroll taxes

Once you understand how the tax increases would affect your particular situation, there are several specific issues and planning opportunities to consider before the end of the year. Even if it appears unwise to accelerate tax, you want to carefully evaluate your typical year-end decisions.

You may be able to control the timing of many types of ordinary income, including:

• self-employment income,
• bonuses,
• consulting income, and
• retirement plan distributions.

You may also be able to affect tax by timing how you exercise options. The spread between the exercise price and the fair market value of nonqualified stock options (NSOs) is ordinary income when exercised and the holding period for long-term capital gain treatment begins. If you do not plan to hold incentive stock options (ISOs) long enough to qualify for capital gain treatment, you can sell them before rates increase.

You can consider a conversion from a 401(k) or traditional IRA to a Roth IRA now while tax rates are low. Tax will be owed on the amount of the conversion now in exchange for no tax on future distributions if the conversion is made properly.

But the easiest thing to control is capital gains. You can trigger gain and pay tax on stock and other securities without changing position. There is no wash sale rule on capital gains, so stock can be sold and bought back immediately to recognize the gain. But if much of your net worth is tied up in one asset because you're deferring the tax bill on a large gain, this might be a good time to reallocate that equity. Turning over assets besides securities will likely involve higher costs and more complications. Strategies that seek to recognize gain but allow you to retain some control or use of the assets must satisfy rules that determine whether ownership has indeed been transferred effectively. You may also consider electing out of the deferral of gain recognition available in an installment sale. Deferred income on most installment sales can be accelerated by pledging the installment note for a loan.

Pass-through vehicles such as partnerships and S corporations are taxed at the individual level, so remember entity-level decisions can accelerate income and defer deductions for you as a partner or a shareholder. But remember that accounting method changes and other depreciation decisions can delay deductions, and decisions on advanced payments can accelerate income — but these decisions but will continue to delay deductions and accelerate income incrementally in future years. It is NOT likely that there are many situations where this will help.

Special considerations for Medicare tax

The new Medicare tax on investment income includes an exception for active trade or business income and gain on the sale of trade or business assets or S corporation shares. Owners in pass-through businesses should start thinking of strategies to deal with the Medicare tax before it takes effect in 2013. If it is possible to reorganize business interests and activities so that they meet the test for active rather than passive income (without causing it to be considered self-employment income) this may save significant taxes in the future.

Transfer taxes

Exhausting your gift tax exemption during your lifetime is often a solid transfer tax strategy. The estate and gift taxes are "reunified" in 2012, meaning that using your gift tax exemption will reduce your estate exemption at death. However, giving away assets now can save transfer taxes in the long run by removing any appreciation and annual earnings from your estate. Assuming modest 5% after-tax growth, $5.12 million can easily turn into more than $13.5 million over 20 years.

Making taxable gifts at the currently low 35 percent gift tax rate can also create benefits. For one, the amount of gift tax paid is removed from the estate. The gift tax is a "tax exclusive" tax because you do not pay tax on the gift tax itself, while the estate tax is "taxinclusive." For example, if you had a taxable estate of $1.35 million and gave it all away during your life, your heir could receive a full $1 million gift with your paying gift tax of $350,000 (35 percent). If your estate is instead transferred at death, your heir would receive only $877,500 after paying 35 percent, or $472,500, on the full $1.35 million. Even more important, making the gift now can remove future appreciation and earnings from your estate.

Many tax strategies can help you leverage your gift tax exemption and get more value from your gifts, and they are more valuable than ever with today's historically low interest rate and depressed asset values. These strategies include:

• grantor retained annuity trusts (GRATs),
• sales to intentionally defective grantor trusts (IDGTs),
• transfers to a family limited partnership (FLPs), and
• transfers to a charitable lead trust (CLTs).

Regardless of where the exemption amounts and rates end up, you should review your plan regularly to ensure it fits in with any changes in tax law and your circumstances.

XERO : Kiwi Startup Does Impossible: Makes Accounting Fun

My Say & Andrew Ferrier for Forbes writes: Challenging older, slower companies is all in a day’s work to many technology start-ups—and nowhere more so than in New Zealand.  A dual Canadian/NZ citizen, I relocated to New Zealand nearly 10 years ago to lead its biggest company, multinational dairy giant Fonterra, and have spent the last decade watching this country successfully compete in the global economy.  While New Zealand has a population smaller than Los Angeles, local software companies are becoming known for demonstrating a nimbleness mirroring the entrepreneurial spirit of the Kiwi nation itself. That is, they are quick to deliver innovation, and more economically powerful than size might suggest.
In my observation, companies from New Zealand, recently named Forbes “Best Country for Business”, share a cultural focus on speed to market and problem-solving.

For example, Xero, which makes accounting software for small businesses, is emerging as the number one challenger to Quickbooks in the U.S. market. Its next step is taking on industry monolith Intuit, by endearing itself to business owners who profess that Xero software “makes accounting fun.”  The company’s easy-to-use product creates a one-stop shop for small businesses to perform routine accounting functions. When the owner is often also the one keeping the books, simplifying functions like bank reconciliations, invoicing, bill paying, payroll and expense claims can be like a gift from the heavens.  Or the cloud….Xero’s cloud-based functionality also increases accessibility, as small business customers and their accountants alike are able to access the company’s financial information anywhere, anytime.
So how does a seven-year old company from this small country take on the industry’s two largest players?  Xero, co-founder and New Zealand serial entrepreneur, Rod Drury, asserts that for Internet-based businesses, the paradigm is “the fast eats the slow,” and company size – or home-market size – is no longer a determining factor in success.
In fact, incumbent companies of a certain size (read: larger firms) are many times sandbagged by legacy constraints like outdated technology platforms or high overhead costs.   Newer, smaller companies can be more agile – and Xero does so within a quintessentially “Kiwi” paradigm that its leaders – and other New Zealand business owners – say provides an inherent edge.

The Need for (Global) Speed
Due to our small domestic market, Kiwi companies are focused on building and exporting the best product in the world – not just on our own shores—and getting it there quickly.  This speed-to-market mindset pervades our most successful companies.
In the case of Xero, Drury and his co-founder, Hamish Edwards, set out to build a software program that is “beautiful”, and to get small businesses excited about accounting.  Yes: excited about accounting. I know that is counter-intuitive, but that’s exactly the point – to develop an enterprise software program that mimics some of the best products developed for the consumer market when it comes to usability and design.

A 2012 Xero hire from Intuit notes: “It was like a Mac – a balance between simplicity and elegance.  Everything I wanted to see, and only what I wanted to see, was in one place.  It wasn’t cluttered, bloated, or confusing.  As I dove in further, it got even better.” Comments from Xero users such as the following — “I think I may love Xero a bit too much. It’s addictive. And fun. Which for an accounting system must be unusual!” – has helped the company reach 120,000 customers, doubling every year. This year’s   revenue figure for the first six months already exceeds the previous 12 months.

As all entrepreneurs know, designing a stellar product is only half the challenge–you need capital to grow.  Interestingly in the case of Xero, New Zealand’s picturesque scenery and ‘adventure capital’ status has been a major factor in the company’s success. Xero investor and PayPal co-founder Peter Thiel fell in love with New Zealand as a tourist and began engaging with the local business community after purchasing a vacation home here.  To date, he and others have invested more than $100 million into Xero.

So, what’s next?  After spending $50 – $70 million to bring the software and its parent company fully in the cloud, Drury is just getting started.  He believes that the next wave of technology innovation will be focused on small business market solutions, and he’s positioning Xero to capitalize on this trend by providing 24/7 global coverage to customers, from over 320 employees worldwide and counting.  His sights are set on connecting small businesses to more and more financial services, with Xero serving as the hub in an app ecosystem, in a similar way that Apple connected app developers with their customers.  Another challenge is to leverage Xero’s “big data” – so far the company has processed over $140 billion in transactions – to develop more innovative services for small businesses based on their spending habits.

Like many serial entrepreneurs, the success of Xero can’t be fully expressed in financial terms for Drury.  His pervading goal is to develop something purposeful.  With small businesses being the largest contributor to Gross Domestic Product in most – if not all – countries, he wants to help make them more productive, which will have an impact in every part of the economy.

Entrepreneurs – regardless of location – have the ability to take on incumbents by changing the rules of the game, and delivering a better product, in timeframes that respond to customer needs.  And incumbents will struggle to catch up due to legacy constraints.  In Xero’s case, they set out to make accounting fun, after realizing that small business owners and accountants are looking to be engaged and entertained with technology in their professional lives as much as their personal lives.  And they are doing it the Kiwi way – solving problems, and delivering faster than the competition.

These 10 tax deductions should be on your radar

Amy Feldman for Reuters writes: Americans claim more than $1 trillion worth of deductions at tax time. And whether you think the tax code should have more write-offs or fewer loopholes, you might as well get your piece of that pie while it's on the table. That means grabbing every available deduction, even the ones you may not have thought about. Here's a helpful starter list for your 2012 returns.

TAXES ON YOUR NEW CAR

If you blinked at year-end, you might have missed the revival of the state sales tax write-off, which lets taxpayers choose between deducting state income taxes or state sales taxes.

That makes it a no-brainer for itemizers who live in Florida or other states without an income tax. While it won't generally make sense for those who live in high-tax states like New York or California, it may be worthwhile for retirees who shelled out for something big, like a boat or a car. For guidance, check out the Internal Revenue Service's online calculator (here).

SUPPLIES YOU SENT TO SANDY VICTIMS

You probably already keep track of the money you donate to your favorite causes. You can also write off food you bought for a homeless shelter, pens you donated to an after-school program and the like. And if you drove your car for charity in 2012, you get to deduct that, too, at a current rate of 14 cents per mile.

If you scoured your closets for clothes to send to Hurricane Sandy victims, don't undervalue them. You can use software like ItsDeductible from Intuit Inc., publisher of TurboTax, or H&R Block Inc.'s DeductionPro to come up with the right value. And yes, you'll need receipts.

THOSE CRUSHING STUDENT LOANS

You're allowed to write off up to $2,500 a year in student loan interest, and you can claim it even if you don't itemize your deductions, though there are income limitations. If you paid extra in an effort to pay down the loan faster, you can deduct the interest portions of those voluntary payments, too.

BREAST PUMPS AND ACUPUNCTURE

The IRS has a much more lenient description of medical costs than your health insurer probably does. Lots of expenses, including breast pumps and their accessories, eyeglasses, hearing aids, acupuncture treatments and weight-loss programs are often deductible. So is the travel to your doctor's appointments (whether in your own car, at 23 cents per mile, or by taxi). Want a laundry list? Get a copy of the IRS's Publication 502.

Of course, there is a catch: You can only deduct the amount of medical expenses that top 7.5 percent of your adjusted gross income.

MOM'S CARE

Families with children get to count their kids as dependents (the exemption is worth $3,800) and take the child tax credit ($1,000 per dependent child under the age of 17). If you have kids, you probably are well aware of that. You may not realize that you may be able to count your aging parents (or other relatives) as dependents as well. The rules are tighter here: In general, your parent must make less than $3,800 (excluding Social Security), and you (along with siblings) must pay more than half of her bills.

THE HIGH-END LINKEDIN SUBSCRIPTION

Job switchers, take heart: You can deduct the costs of preparing your resume, traveling to interviews, outplacement fees and other job-hunting necessities. And if you take a job at least 50 miles away, you can write off the cost of that move. While job-hunting costs get lumped into the miscellaneous deduction (which you can only take once it's above 2 percent of your adjusted gross income), there's no such limit on moving expenses. In fact, if you qualify, you can get the tax write-off even if you don't itemize.

INVESTMENT ADVICE

Fees for financial advisers are deductible. So is the cost of traveling to meet with your financial guru in person, and subscriptions for financial publications. But sorry: Costs to go to investment seminars and hear get-rich-quick schemes are not generally deductible.

HIGH SPEED INTERNET AND VACUUMING

Self-employed workers get a grab bag of deductions: the home office (don't forget the pro-rated electric bill, homeowner's insurance and cleaning costs for that part of the house), health insurance and whatever subscriptions, books and conferences you need to keep the businessgoing. And if you bought a new laptop, set up a new phone system or purchased some other big-ticket piece of equipment for your business, you can write off the cost immediately rather than depreciating it over time, a difference that may sound ridiculously geeky but can be extremely valuable.

HOUSING BUBBLE FALLOUT

If you struggled through negotiations with your lender last year that resulted in part or all of your mortgage debt being forgiven, you don't have to report that amount as income, as long as it was for your primary home. And you can deduct private mortgage insurance, the coverage that lenders typically require for those who make downpayments of less than 20 percent, though income limits apply to this one, too.

FUTURE FUN

OK, so you probably didn't forget your individual retirement account or other retirement plan contributions. But this is a big item and one of the only ones you can still change for the 2012 tax year.

Don't forget that you have until April 15 to sock away $5,000, ($6,000 if you're 50 or older) into an IRA. Depending on your income and work situation, this might be a deductible IRA or a Roth IRA. Whether you get a tax break now or later, in a couple of decades you'll probably be happy you remembered this one.

Deductible Me / Help clients understand how to get all the tax deductions they are entitled to, including home, health and education, and possibly even the fees they pay to you the CPA.

Kevin McKinley for Wealth Management writes: What do health care, housing, or higher education have in common? Nobody enjoys paying for it. In fact, the only expenditure even more dreaded is income taxes.

But there is some good news: The tax code offers some methods to use money spent on the first three to reduce what they owe on the latter. Here’s how.

Home Sweet Home

The first way homeowners can cut their income taxes is via what they begrudgingly pay in property taxes. However, the break is only optimal for those who have enough deductible expenses (including property taxes) to exceed the standard deduction.

In 2013, the standard deduction is $6,100 for single filers and $12,200 for married couples filing jointly. One trick clients can use to maximize the tax-deductibility of property taxes is to “bunch” more than one year’s worth of payments into the same calendar year.

Mortgage interest paid on both a primary mortgage and a home equity loan (or line of credit) can also be itemized. The potential tax deduction couple with today’s low interest rates make borrowing against home equity a better choice than most other loan options available to your clients who are making larger purchases (such as a car or boat).

Clients who have paid “points” to obtain a mortgage can amortize the cost of the points over the life of the mortgage. If they refinance to a new mortgage, they can also immediately deduct the unamortized points of the previous mortgage.

Don’t forget the tax help available to homeowners who are making qualifying energy-efficient improvements. Some projects could bring a break equal to 10 percent of the cost, for as much as $500.

For more information,see Publication 530 (“Tax Information for Homeowners”) atwww.irs.gov, and research tax credits for energy-efficient remodeling and improvements at www.energystar.gov/taxcredits.

Health Care Deductions

Higher-income clients who have the option available should strongly consider the purchase of a high-deductible health insurance policy, and pair it with a health savings account (HSA). They’ll save money on policy premiums and generally reduce their taxable income by the amount of money deposited in to the HSA.

Working clients will be happy to know that flexible spending accounts (FSAs) may still be offered by their employer, but the accounts have been made less attractive. In 2013, the contribution limit has been reduced to $2,500. Funds in FSAs are still “use it or lose it,” meaning that any money in the accounts that isn’t spent by the annual deadline is forfeited.

In a worst-case scenario, your clients may be liable for medical expenses on their own. Those who fall into this unfortunate situation may at least be able to use the costs to cut their taxes. In 2013, those who pay medical expenses with their own money can deduct the amount that exceeds 10 percent of their modified adjusted gross income. The threshold is 7.5 percent for those over age 65.

Long-term care insurance premiums is another medical expense that may be tax-deductible. The amount of annual premium that may be deductible in 2013 depends on the client’s age, and ranges from $360 for those under 40 to $4,500 for policyholders over age 70.

For more information,see Publications 502 (“Medical and Dental Expenses) and 969 (“Health Savings Accounts and Other Tax-Favored Plans”) at www.irs.gov.

Higher-Ed Breaks

Although some states’ 529 college savings plans offer small breaks on initial deposits, the main tax advantage is that future income and gains that remain in the account are sheltered from taxation.

Eventually, withdrawals can be completely tax-free, as long as the money distributed can be matched up against qualified expenses incurred for a qualified beneficiary.

Even withdrawals taken from IRAs get special treatment, if the money is used for qualified higher education expenses. The distributions still count as taxable income, but clients under 59 ½ can avoid the additional 10 percent penalty that would otherwise be applied.

Keep in mind that the withdrawals are added on to the client’s income, which may reduce any need-based financial aid awarded in the ensuing year.

The next way to save on taxes when paying for college is the use of tax deductions and credits for out-of-pocket costs incurred on behalf of adult clients and their dependents. The American Opportunity Tax Credit can reduce the income taxes of qualifying families, ranging in amounts from $1,000 to $2,500, depending on the family’s income.

Another potential education tax break comes in the form of the Lifetime Learning Credit. Up to 20 percent of qualifying annual expenses per student can be used, up to a total of $2,000.

Finally, families who don’t qualify for either credit may still be able to deduct up to $4,000 of annual tuition and other similar expenses from their taxable income—even if they borrowed money to pay those costs.

Those loans for higher education require the borrower to pay interest but that expense may also be a source of income tax savings. The interest amount incurred is sent from the lender each year to the borrower on IRS Form 1098-E. The deductible amount is the lesser of the actual interest cost, or $2,500.

For more information,see Publication 970 (“Tax Benefits for Higher Education”) atwww.irs.gov.

Deducting You

Of course, you should recommend that your clients consider these tax breaks with the help of a qualified CPA or income tax professional—whose fees may be tax-deductible.

But don’t forget that the annual account maintenance and investment advisory fees the clients pay to you may be deductible, as well. The fees are lumped in with “miscellaneous itemized expenses” that can be deductible to the extent the amount exceeds 2 percent of the taxpayer’s adjusted gross income.

For more information,see Publications 550 (“Investment Income and Expenses”) and 529 (“Miscellaneous Deductions”) at www.irs.gov.

Advisers Warn of Tax Traps in MLPs (master limited partnerships)

Arden Dale for the Wall St. Journal writes: Master limited partnerships, or MLPs, are touted as a way to capture dividend income and hedge against inflation. They also offer some tax advantages when held in taxable accounts.

But MLPs also can also create tax problems. And during this time of year as investors do their tax returns, those tax snares show up in stark relief.

State and federal tax requirements for MLPs are so daunting that some financial advisers recommend against them for that reason alone. Others warn that stashing MLPs in retirement accounts can cancel out the tax benefits.

"It is almost a situation of 'buyer beware' because in some instances, I've had clients not fully understand the tax consequences that come from investing until they file their returns," said James H. Guarino, an accountant and certified financial planner at MFA--Moody, Famiglietti & Andronico LLP in Tewksbury, Mass.

Publicly traded, MLPs finance the construction and operation of pipelines and other energy technologies. Since a partnership doesn't pay income tax as a corporation would before paying shareholder dividends, partners incur only one layer of tax and they can defer some of it. They also get a tax deduction for their share of depreciation on equipment.

The appetite in the U.S. for these investments is high, and more are being minted.

Yet advisers such as Mr. Guarino are quick to note potential problems. He sees more people who want to put partnerships into their individual retirement accounts. Those accounts already provide tax deferral, so the tax benefits of the partnership could well go unused. And, because partnership income over $1,000 is subject to a levy known as the Unrelated Business Income Tax, the retirement account may have to file a 990-T tax return and pay income tax.

Also of concern to many advisers is that reporting MLPs properly on state and federal tax returns can be a knotty and frustrating process. Not only do MLPs issue K-1s--notoriously complicated tax documents that often arrive just in the nick of time for the April 15 tax deadline--but some require tax returns and payments for numerous states.

State tax filing requirements can be so onerous that some advisers avoid MLPs on that score alone. The biggest problem is with partnerships that hold pipelines that run through many states. Each state sets an income threshold and an investor must file a tax return in a state if the partnership income exceeds that amount.

"One master limited partnership might give you exposure to 12 different states, and we don't want to put our clients in the position where they have to file those state taxes," said David S. Morgan, a principal at JMG Financial Group Ltd., an investment adviser in Oak Brook, Ill., with more than $1.4 billion under management.

His firm steers clients away from individual MLPs because of these "severe tax complications," Mr. Morgan said. Clients instead can get indirect exposure to partnerships--and without the tax issues--through exchange-traded notes, exchange-traded funds and mutual funds, he said.

Nevertheless, two clients of Mr. Morgan do invest directly and live with the tax consequences: One is the retired chief financial officer of an insurance brokerage, and the other a former colleague.

And, indeed, there are plenty of investors who are willing to take on the tax consequences.

Dave DeWitt, an adviser in Wayne, Pa., who manages MLPs for financial advisers and individual clients, has one client, a retired entrepreneur, with $10 million invested in them. Baby boomers looking for a good source of income, he said, can find that in partnerships.

"It's real assets, real pipes in the ground," Mr. DeWitt said.

Taxes? He leaves those issues to accountants like Dwight Beucler, who has a nearby accounting firm and a lot of experience with MLPs.

In the meantime, Mr. Beucler is currently knee-deep in tax filings for MLPs. He estimates he will spend three days entering information onto a tax return for one client who invests heavily in the partnerships. There are so many K-1s and other documents for the client, a retired chief executive, that he can't store them in a drawer as he does for other clients, but holds them in special three-ring binders.

"I have someone check my work," said Mr. Beucler.

A checklist of steps that small business owners can take to help navigate changes stemming from the recently enacted American Taxpayer Relief Act (ATRA) 2013

CPA Practice Advisor writes: comes: Human resources and payroll outsourcing solution provider ADP has put together a checklist of steps that small business owners can take to help navigate changes stemming from the recently enacted American Taxpayer Relief Act (ATRA). By carefully selecting an employer-sponsored tax-qualified retirement plan, business owners can get much-needed relief from tax increases they experience as a result of ATRA, with the added benefit of helping their employees prepare for retirement.

Passed late last year, ATRA created several important changes to the tax law for both income and payroll taxes in 2013. The Act effectively maintains the reduced income tax rates adopted in 2001 and 2003 for individuals earning up to $400,000 and joint filers earning less than $450,000. Income above those levels will be taxed at 39.6 percent, up from 35 percent. The expanded 15 percent bracket for joint filers, commonly referred to as marriage penalty relief, also was extended. These tax rates were extended permanently for wages paid after Dec. 31, 2012.

Meanwhile, employee Social Security tax rates jumped to 6.2 percent for 2013 wages, up to the taxable wage limit of $113,700.  In 2011 and 2012, the Social Security tax rate was 4.2 percent.  For more information about ATRA and the resulting tax law changes, click here to view a video featuring ADP Retirement Services' Chris Augelli.

"Taxes are rising for all Americans, regardless of age or income bracket," said Chris Augelli, vice president of product marketing and business development for ADP Retirement Services. "The good news is that employer-sponsored tax qualified retirement plans can provide some relief in this new financial environment."

In 2013, workers can invest more of their pre-tax earnings in an employer-sponsored retirement plan. The maximum an individual employee can contribute to a 401(k) plan is $17,500, up $500 from last year. Individuals ages 50 and older can now contribute an additional $5,500 in "catch-up contributions" in their 401(k) accounts. This is $500 more than was allowed last year.
Similarly, individuals participating in a SIMPLE IRA plan can contribute an additional $500 to their IRAs in 2013, up to a maximum of $12,000 per year. Those who are 50 and older can make an additional $2,500 in catch-up contributions, also a $500 increase over last year's limit.
"One of the advantages of these plans is they allow people to save for the future with pre-tax dollars," said Augelli. "This lowers their current federal taxable income, which may enable them to pay less in federal income taxes and take more income home."

ADP's retirement plans are easy-to-manage and provide the resources, materials and online tools employees need to become retirement ready. ADP works with companies to provide retirement savings plans that are tailored to employers' specific needs and align with their strategic business goals.

"ADP does not sponsor or manage its own investment funds, so we can be objective about investment options in our plans," said Augelli. "In this regard, our clients never have to worry about a conflict of interest with regard to fund make-up, and we fully disclose our compensation we earn from the investment funds we make available. They know the information we provide to them is based solely on what is best for their business and their employees. And we're always here to help clients understand the latest laws, regulations and best practices for ensuring a secure retirement, regardless of the economic or political climate."

3 Things Sapping Your Returns: Fees, Taxes, and Inflation

Investorguide.com writes: Most of us want the best possible returns on our investments. However, even as you look for better returns, you might be overlooking some important items that could be reducing your real returns. As you plan your future, you need to do what you can to offset the effects of fees, taxes, and inflation on your portfolio. You can’t get rid of these costs entirely, but you can limit their impact.

Fees

When you make your return on investment calculations, you might not consider the effect of fees. However, you shouldn’t underestimate the cost of fees over time. Some of the fees that might be weighing on your portfolio include:

• Transaction fees: Each time you make a trade, whether you buy or sell, you pay a transaction fee. Frequent trading can lead to high transaction fees over time. Most investors do better if they carefully think through their transactions, and limit the number of transactions taking place.
• Expense ratios: All funds come with expense rations. Whether it’s an actively managed mutual fund, an index fund, or a low-cost ETF, there’s going to be an expense ratio. Each year, you pay fees based on the value of your shares. The more shares you have, and the higher the expense ratio, the more you pay. Choose funds with lower expense ratios.
• Management fees: If you have someone else managing your money, you will likely pay management fees. This can also include the fees associated with the plan management of your employer’s retirement plan. Whenever possible, look for the best value, choosing to get the best possible management at the best possible price.
• Other fees: Be on the look out for other fees. With mutual funds, these fees might come in the form of a sales load. There are other fees, such as brokerage maintenance fees, that you might be charged as well. Pay attention, and look for ways to avoid as many fees as you can.

Taxes

You need begin planning now to offset the cost of taxes. This can be a difficult task, but it’s important that you consider the effect of taxes on your investment returns. Tax-advantaged retirement accounts can help you delay paying taxes until you are in retirement (Traditional qualified retirement accounts), or they can provide you with a way to pay taxes now, and avoid paying later (Roth retirement accounts).

The IRS May Attempt To Disallow Your Charitable Deductions

Steven Packer for Duane Morris writes: As you compile your tax material for the preparation of your 2012 income tax returns, now is the perfect time to examine your files to ensure you have all required records to support your charitable contributions, particularly in light of a recent Tax Court decision.

In Durden v. Comr., T.C. Memo 2012-140, the Tax Court surprisingly sided with the IRS by strictly applying the requirement that a taxpayer must be in possession of a "contemporaneous written acknowledgment" of the contributions, along with a statement that no goods or services were received by the taxpayer from the charity, prior to filing the tax return claiming the donation.

This case involved taxpayers who made multiple contributions to their church in amounts greater than $250. The church provided a statement to the taxpayers acknowledging the contributions, but failed to mention in the statement whether any goods or services were provided in exchange for the contributions. Upon appeal, the Tax Court affirmed the IRS decision, noting that the law requires a timely affirmative statement that no goods or services were received by the taxpayers. This "contemporaneous" acknowledgement must be received prior to the filing of the tax return or the due date of the return (including extensions), whichever came first, the court declared. As a result, the taxpayers were denied an otherwise valid charitable contribution deduction of more than $25,000. The deduction could have been easily preserved if the statement they received from the charity simply included:

• The amount of the cash contributions and a description; and
• A good-faith estimate of the value and description of any goods or services provided to the donor in exchange for the contribution, even if the value was zero.

Although substantiation is required for all contributions, the requirements vary depending upon the type and value and are discussed below.

Cash Contributions

Contributions by cash or check of less than $250 must be substantiated by a bank record, such as a cancelled check or a written communication from the donee organization, noting the organization's name and address, and the date and amount of the contribution. A contribution log is insufficient.

Contributions of $250 or more must be substantiated with a bank record and acknowledgement from the donee organization. If the aggregate value of multiple contributions is greater than $250, but each separate contribution is less than $250, the written receipt requirements do not apply. For example, three separate donations of $100 each do not require a written acknowledgment if a written bank record or receipt exists.
The charitable acknowledgement must clearly provide:

• the amount donated;
• whether the organization provided any goods or services to the donor in return for the contribution;
• a good faith estimate of the value of the goods or services, if any, received by the donor; and
• the acknowledgement must be received by the due date of the return, including extensions, or the date the tax return is filed, whichever is earlier.

If goods or services are received, such as a dinner or theater tickets, in return for contributions, the deduction is limited to the excess of the contribution over the value of what was received.
Contributions through payroll deductions can be substantiated with a pay stub, Form W-2 or other document issued by your employer that reports the amount withheld for payment to a charity. For a single contribution of $250 or more, documentation with a pledge card or other document prepared by the charity including a statement that it does not provide goods or services in return for contributions made by payroll deduction is acceptable. The deduction from each wage payment is treated as a separate contribution for purposes of the $250 threshold.

Non-Cash Contributions

Taxpayers who contribute property other than cash have to maintain a receipt from the donee organization that clearly discloses the organization's name, date and location, as well as a detailed description of the property. If a receipt cannot be obtained, a reliable written record of the contribution is required. The information required in such a record depends on factors, such as the type and value of property contributed.

If you contribute publicly (as well as non-publicly) traded stock, it may be prudent to maintain written records and an acknowledgement of the contribution. If artwork is contributed, similar rules apply, with a qualified appraisal requirement if the art is valued at more than $20,000. If you contribute an auto, boat or plane, a Form 1098-C must be obtained, and written records should be maintained. All other non-cash donations must be supported by a receipt or acknowledgement, as well as written records. Taxpayers anticipating claiming these types of contribution deductions may want to consult with a qualified tax professional, as the rules are complex.

Contributions of Services

While the value of services contributed is not deductible, some deductions are permitted for out-of-pocket costs incurred while performing services for a charitable organization. Be sure to record the dates and amounts of the expenses incurred, the type and date of services performed and the organization for whom the services were rendered. Also, you should maintain receipts, canceled checks and other reliable written records relating to the services and expenses.

Because written receipts are required for contributions of $250 or more, the written receipt requirement will be satisfied if adequate records are maintained to substantiate the amount of out-of-pocket expenditures, along with a statement from the charity containing a description of the services provided; the date the services were provided; a statement of whether the organization provided any goods or services in return; and a description and good-faith estimate of the value of those goods or services.

The substantiation requirements for charitable donations can be confusing, therefore consultation with a qualified tax professional may be warranted if there is any uncertainty regarding what documentation to obtain and maintain. As the IRS is becoming increasingly aggressive in denying contribution deductions, it is important to collect the necessary documents now, prior to filing your tax return claiming the deduction—as opposed to a year or two down the road—in the event of an audit, when the substantiation may be more challenging to unearth or not be acceptable by the IRS or courts.

Your Smartphone's Newest Skill: Filing Your Tax Return

Mia Taylor for the Street writes These days you can use your smartphone for just about everything, including e-filing your taxes.   In fact, submitting tax returns via a mobile device is the fastest-growing way of filing, according to H&R Block  Product Specialist Heather Watts.  "There's a lot more people, getting a lot more comfortable doing things on their smartphone," Watts says. "If you have your W2 in front of you, it can be done in 15 minutes."

E-filing via a smartphone is incredibly convenient thanks to various technological advances. For instance, with H&R Block's smartphone software, called the 1040EZ App, you can snap a picture of your W2 with your phone and the software takes the information from the picture and inputs it into your tax forms. This feature eliminates a great deal of typing or manual entry of information.

TurboTax  has a similar smartphone app for simple tax returns, with similar photo capabilities. Called SnapTax, the TurboTax version has received more than 8,000 ratings and five stars from users, says Julie Miller, TurboTax's director of public relations and social media. Their software is free to download but charges $20 to file each return. H&R Block's smartphone software is free when used to file a simple federal and state return.
Filing from your smartphone, however, is not recommended for people with more complex returns, which include a Schedule A or Schedule C, Watts says.

If you want to e-file via a tablet such as an iPad, there's another version of software available from both companies. Because the screen on an iPad is larger than that of a smartphone, the software it uses is slightly different, mimicking the more traditional software used online. Neither company charges to download their iPad software. TurboTax charges a fee when filing, though, with prices starting at $29.99 for federal returns and $36.99 for a state return.

And even do-it-yourself filers occasionally have questions, right? The companies have come up with a solution. Taxpayers using the deluxe and premium versions of H&R Block At Home for the iPad can chat live with a company tax professional, and the same goes for TurboTax: Before hitting the send button on their e-filing, users of TurboTax software can get free tax advice via a telephone number posted on the company's website.
"There's this hybrid out there of 'I want the convenience of doing my taxes myself from home, anytime, anywhere, but I want to know that if I have a question I can call a highly qualified professional," Miller says.

Miller and Watts predict that technology will continue to become more accommodating when it comes to filing taxes on your own. Future conveniences incorporated into the tax filing process might include Skyping with a tax professional or other ways of "virtualizing" the experience, Miller says.

"The [mobile] market is still in its infancy," Watts adds. "Meaning we're going to see a lot more people using mobile devices to transact. The more we can make it easier on clients, the better."

"As we look to future, what other types of documents would you want to take pictures of and pull data from?" Watts adds. "That's where I see the market heading. How do I get to the point where I don't have to populate the documents myself?"