Saturday, January 4, 2014

Tax efficiency vs. fees - A 401k vs. taxable account question

Over at Bogleheads we read: Tax efficiency vs. fees - A 401k vs. taxable account question


Tax efficiency vs. fees - A 401k vs. taxable account questioby murphyslaw86 » Fri Jan 03, 2014 8:00 pm

Background: The only bond fund in my 401k is the PIMCO Total Return fund (PTTRX - ER: 0.46%). The only index fund option, stock or bond, is the Spartan S&P 500 fund (ER: 0.05%). I'm a strong believer in the Bogleheads / index investing philosophy, but I also can see the value of tax efficient asset allocation.
Currently, my full 401k is in the Spartan S&P 500 fund. My bond allocation is currently split between the Vanguard Total Bond Mkt fund in my Roth IRA and the Vanguard Intermediate-Tax Exempt Bond fund in my taxable account (can't fit my full 20% bond allocation in my Roth at the moment). I also have an S&P 500 fund, extended market fund and total international stock fund in my taxable account to cover all my bases. Here's a snapshot of my current portfolio - http://imgur.com/tXQq60E
I know stock index funds are very tax efficient, so it would make more sense to have all my equity holdings in my taxable account and have my 401k be all bonds, but are the tax advantages enough to justify me switching to a slightly higher cost (0.41% diff in ER) non-index fund like PTTRX? It's one of the biggest and best performing bond funds in the world, so I figure if there's any time it makes sense to go away from index funds, this would be it.
What do you guys think?
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Joined: 10 Aug 2013

Re: Tax efficiency vs. fees - A 401k vs. taxable account queby Laura » Fri Jan 03, 2014 10:14 pm

Hi murphy,
I think your portfolio choices are just fine. The only thing I would actually suggest doing in the taxable account is switching the S&P 500 and extended market funds for a Total Stock Market fund. I know why you made this choice but trying to keep those two in balance in a taxable account can be a challenge and you are locked in for a long time in a way that will only become increasingly more expensive to switch in the future.
For the bonds, I think your current choices are fine but switching would be okay as well. I like to go with the sure thing, low costs. so I would probably stick with what you have.
Laura
Posts: 5614
Joined: 19 Feb 2007

Re: Tax efficiency vs. fees - A 401k vs. taxable account queby grabiner » Fri Jan 03, 2014 10:18 pm

The 0.36% expense difference is probably more than the tax savings by holding bonds in the 401(k). Therefore, I would prefer holding the S&P index in the 401(k), bonds in your IRA if possible, and any additional bonds as I-bonds and munis in taxable, which is what you are doing. David Grabiner
Advisory Board
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Joined: 21 Feb 2007
Location: Columbia, MD

Re: Tax efficiency vs. fees - A 401k vs. taxable account queby murphyslaw86 » Sat Jan 04, 2014 3:32 pm

Laura wrote:The only thing I would actually suggest doing in the taxable account is switching the S&P 500 and extended market funds for a Total Stock Market fund. I know why you made this choice but trying to keep those two in balance in a taxable account can be a challenge and you are locked in for a long time in a way that will only become increasingly more expensive to switch in the future.



Thanks for your response. So, if I switch my S&P and Extended Market funds for a TSM fund, won't I be significantly tilting towards large cap? I've received this recommendation before, but I'm not sure I understand it. Don't I want to own as close to the true market weights as possible if I'm adhering to the Bogleheads philosophy. If I just rebalance as necessary every year or so, can't I keep my ratio somewhere around 20-25% small cap pretty easily? Why will it become more expensive in the future? I'm probably not going to be adding any new money to my taxable account for many years (all contributions will be Roth IRA & 401k), if that makes any kind of a difference.
Posts: 8
Joined: 10 Aug 2013

Re: Tax efficiency vs. fees - A 401k vs. taxable account queby Laura » Sat Jan 04, 2014 3:40 pm

The total stock market fund is the true market weight. By splitting the market into large and mid/small you are overweighting one or the other unless you rebalance to maintain the true market weight. It is easier to maintain market weighting in a total market fund. And, as companies grow or shrink resulting in a move from one category to the other you are not hit with a taxable event as the fund adjusts by selling the company out of one and then buying it into the other.
Laura
Posts: 5614
Joined: 19 Feb 2007

Re: Tax efficiency vs. fees - A 401k vs. taxable account queby murphyslaw86 » Sat Jan 04, 2014 5:24 pm

Laura wrote:The total stock market fund is the true market weight. By splitting the market into large and mid/small you are overweighting one or the other unless you rebalance to maintain the true market weight. It is easier to maintain market weighting in a total market fund. And, as companies grow or shrink resulting in a move from one category to the other you are not hit with a taxable event as the fund adjusts by selling the company out of one and then buying it into the other.



I understand that, but as I mentioned in my original post, the only index fund in my 401k is a S&P 500 fund. There's no TSM available there. So, if I have my whole 401k in that fund and have only a TSM fund in my taxable account, then I'll have a really heavy tilt towards large cap (S&P 500 + majority of TSM) overall. The only reason I have the S&P 500 fund and the extended market fund in my taxable account is to essentially recreate a a TSM fund between my 401k and taxable accounts.
Does that make more sense?
Posts: 8
Joined: 10 Aug 2013

Re: Tax efficiency vs. fees - A 401k vs. taxable account queby Laura » Sat Jan 04, 2014 5:29 pm

Yes but to be honest, it probably doesn't matter much. If you look how closely the S&P 500 tracks the TSM fund you can see what I mean. If you want to keep two funds, no real harm done but I have accidentally boxed myself into corners that I later regretted by holding things other than total market funds in taxable. One I am in a position to restructure my portfolio for one reason or another I find it difficult to do with the separate funds.
Posted on 8:30 PM | Categories:

Apps to Track Income and Expenses: BillGuard, Level Money, & Mint

 Ana Savfa for Periscope Post/NY Times writes:   Several applications are available to help consumers set up a budget and track their income and expenditures.
There’s something brilliant, but also insidious, about services like Amazon Prime, where you don’t have to reach for your credit card to pay. Spending is painless.
Credit cards have separated us from our cash. Services like Amazon Prime, iTunes and others have separated us from our cards. And once we can pay more easily with our smartphones, consumers will experience yet another degree of separation. All of this means that consumers need to work a bit harder to “feel” what they’re spending — and keep track of it. Behavioral scientists will tell you what you intuitively know: Willpower alone will take you only so far, and restrictive budgets eventually fail. But this is the time of year when many people try to get a grip on their spending.

“Look for structural solutions or things that change your environment so you don’t need to be constantly vigilant,” said Stephen Wendel, a behavioral social scientist at HelloWallet, which helps employers provide financial guidance to their workers. “My favorite technology is the automatic transfer, so you don’t see the money in your account.”

There are some new financial apps that try to acknowledge our innate weaknesses as humans, most of whom despise deprivation and keeping tabs on every last dollar spent.

I spent the last week testing several cash management tools, including the newest apps targeting younger generations as well as improvements made by established services like Mint.com that still dominate the market.

A note of caution: To use most of these apps and services, which promise bank-level security, you need to be comfortable entrusting them with the passwords to your financial accounts. To analyze your spending, they need to collect and then ferry data about your income and transactional history into their programs; many rely on established players like Yodlee and Intuit for that plumbing and do not have the ability to move your money. I’ve also listed a couple of more traditional, and more labor-intensive, options.

LEVEL MONEY Less than three months old, this app is intentionally simple: You can’t create fancy charts that categorize every last dollar, nor does it wag a virtual finger to alert you when you’ve spent too much on restaurants in the last month. Instead, it acts as a spending meter or a gas gauge: On the first of each month, it fills up with your estimated income based on your previous history; from that, the app automatically subtracts your recurring bills and a saving rate. (It suggests 7 percent). The app is available for iPhone and is coming soon for Android.

The money remaining is what you can spend, and the app breaks that down on a daily, weekly and monthly basis. The app is connected to all of your credit, debit and banking accounts, so it knows every time you make a transaction and adjusts the money meter accordingly. If you had a day of heavy spending, it will show that you have less to spend for the remainder of the month. “What we wanted wasn’t a budget, but the digital equivalent of opening up your wallet and seeing how much you have left,” said Jake Fuentes, 27, Level’s co-founder and chief executive.

The idea, Mr. Fuentes said, is to focus on decisions in the here and now. It’s that simple — and probably far too simple for many people. The app is geared to people 18 to 35 who are most likely to have less complex financial lives.

You can’t add in your cash transactions and the app won’t work as well for people with inconsistent income and expenses, but the company is working on adding features that will address those issues.

BILLGUARD This app started life as a security service that scanned users’ credit and debit charges for potentially erroneous or unauthorized transactions — a service Target shoppers can surely appreciate now. But last summer, it added a spending analytics tool and personalized savings alerts. The spending feature gives you a snapshot of your monthly spending, though you need be a heavy credit and debit card user for the numbers to have meaning. Every time you swipe a card, the transaction is automatically categorized. It did a relatively good job with the two cards I connected.

The analytics are informative, but one-dimensional. You can compare spending across all accounts with the previous month.  You can compare spending across all accounts with the prior month, but the app doesn’t provide insights into spending relative to income. Those features and customizable alerts will be added  in coming months. “It will be looking out for you almost like the perfect accountant in the background, letting you live your life and when you go beyond a certain threshold it will let you know,” said Yaron Samid, founder and chief executive. The company is also working on letting users add cash transactions, alerts when users are close to incurring an overdraft fee, and other analytics.

The app, which will be available for the iPhone and Android in February, also searches the Web for coupons that you are most likely to use based on your past spending. The app works for two linked accounts, but there’s a one-time charge of $9.99 for up to 10 accounts. Yodlee handles account aggregation.

MINT For several years now, I have had an on-again, off-again relationship with Mint.com, the automated money-tracking service introduced in 2007 and acquired in 2009 by Intuit for $170 million. If you want to get a better sense of where your money is going, keep tabs on your net worth and chart it all with pie and bar charts for different time periods, then Mint is still the most comprehensive tool on the market. LearnVest, which offers a human financial planner if you want one, has a similarly robust free tool, which I’ve reviewed in the past.

Mint’s budgeting tool sets up a starter budget for you — based on up to three months’ spending history — across various categories from groceries to mobile phones. You can add to the list and customize to your heart’s content. If you spend more than you’ve allotted, you can set it up to receive an email or a text message. LearnVest has its own budgeting tool, which also provides some guideposts: You should spend no more than half of your income on essentials and no more than 30 percent on lifestyle expenses.
Posted on 2:51 PM | Categories:

The In-Plan 401(k) Roth Conversion Strategy

Ashlea Ebeling for Forbes writes: Presto! Turn your pre-tax 401(k) into a Roth 401(k). It’s done via an in-plan Roth conversion (also known as an in-plan Roth rollover). It used to be that just a handful of employees could make this bold tax move to build a tax-free retirementkitty, but thanks to an expanded law in 2013 and new Internal Revenue Service guidelines out last month, the opportunity is opening up to more workers.
“Now that the guidance is out, this is going to be a 2014 initiative for employers,” says Alison Borland, vice president of retirement solutions and strategies for Aon AON +0.29% Hewitt. In a survey of 400 employers representing over 10 million employees last fall, Aon found that over the last six years, the percentage of employers that allow Roth contributions (a prerequisite to allowing in-plan conversions) has increased from 11 percent to 50 percent. And 27 percent of those plans that allow Roth contributions allow in-plan Roth conversions. Another 16 percent of companies were planning to add the conversion feature within the next 12 months.
“Now that the guidance is out, this is going to be a 2014 initiative for employers,” says Alison Borland, vice president of retirement solutions and strategies for Aon AON +0.29% Hewitt. In a survey of 400 employers representing over 10 million employees last fall, Aon found that over the last six years, the percentage of employers that allow Roth contributions (a prerequisite to allowing in-plan conversions) has increased from 11 percent to 50 percent. And 27 percent of those plans that allow Roth contributions allow in-plan Roth conversions. Another 16 percent of companies were planning to add the conversion feature within the next 12 months.
“Now that the guidance is out, this is going to be a 2014 initiative for employers,” says Alison Borland, vice president of retirement solutions and strategies for Aon AON +0.29% Hewitt. In a survey of 400 employers representing over 10 million employees last fall, Aon found that over the last six years, the percentage of employers that allow Roth contributions (a prerequisite to allowing in-plan conversions) has increased from 11 percent to 50 percent. And 27 percent of those plans that allow Roth contributions allow in-plan Roth conversions. Another 16 percent of companies were planning to add the conversion feature within the next 12 months.
So the in-plan conversion strategy is an especially smart move for high-net-worth individuals who don’t need all the money in their 401(k) for retirement expenses but want to grow it as an income-tax-free inheritance for their spouse and/or kids. But a conversion can also work well for someone who is young and in a low tax bracket– if the money will be needed in retirement, it’s years away.
Basically, what you do (if your employer allows it) is redesignate money stashed in your traditional pre-tax 401(k) into Roth money, keeping it in the 401(k). In the fall of 2010 Congress allowed this but just for 401(k) money that was “distributable.” That varied by employer, but typically meant your vested balance once you reached 59.5 or retirement age, and in some cases employer match money. Then with the American Taxpayer Relief Act, Congress said that as of Jan. 1, 2013, you could convert everything, including pre-tax salary deferrals, at any age. So you can Rothify your whole account. Or you can Rothify part of it to spread the tax bite over a couple of years.
Once your 401(k) is converted to a Roth 401(k), future earnings grow tax free. So the younger you make the move, the more years of tax-free compounding you get. But here’s how you can really make out. When you leave your employer, you can roll over the Roth 401(k) to a Roth IRA (make sure you make the switch by what’s known as a direct trustee to trustee transfer so you never get a distribution check). You can leave the Roth IRA to your spouse, who doesn’t have to take the money out, and your spouse can leave it to your kids, who will get to dribble the money out over their lifetimes based on IRS life expectancy rules.
Say an employee retires at 62 and rolls his Roth 401(k) into a Roth IRA, and leaves it when he dies at age 80 to his wife, then age 78. When she dies at age 90, she leaves it to their daughter, then 60. That’s 30 years of tax-free growth from when the employee was 62 until his wife was 90. “That’s pretty nice!” says Joseph Urwitz, an employee benefits lawyer with McDermott Will & Emery in Boston. And another 25 years or so of tax-free growth until the account balance is fully distributed at the daughter’s death. (An Obama Administration proposal requiring non-spouse heirs to deplete inherited IRAs within 5 years would limit this third leg of tax-free growth.)
One factor that could push you towards a conversion is if you have deductions to offset the tax cost of the conversion. Scott Kaplowitch, a CPA with Edelstein & Co. in Boston, had a married client in his early 70s with high medical expenses (nursing home costs) do a conversion. The medical expense deduction cut the tax bite, and the client’s younger wife hopefully has many years of tax-free growth ahead of her. “It’s a longevity play,” Kaplowitch says, noting that the analysis has to take into account your age, your health, your tax bracket, whether you need the assets, and whether you might leave the money to charity.
There are some tricky points to watch out for. The IRS guidance, In-Plan Rollovers To Designated Roth Accounts In Retirement Plans, says that only vested amounts can be converted, says Urwitz. (All of your salary deferrals are immediately vested, but employer contributions are typically subject to a vesting schedule, meaning the money isn’t really yours until a certain number of years of employment has elapsed.) Employers can also place limitations on who can convert—such as active employees only. Another warning: just because you’ve converted the pre-tax money into a Roth, you can’t suddenly withdraw it, notes Urwitz.
The in-plan Roth conversion rules apply equally to 401(k)s, 403(b)s, thrift savings plans and 457(b) plans.


Posted on 9:15 AM | Categories:

Best financial apps for the new year

WickerLocalBurlington.com writes: Looking to get financially organized in 2014? Check out these app suggestions, which just might help you keep your resolution. And the best part is, they're free! 
CHECK: This app works to keep you on top of your bills by keeping track of when they’re due and issuing you reminders. It also keeps track of your bank account so you don’t overdraw, and more.  
Free for iOS and Android.

MINT.COM: This app from Intuit lets you manage all your accounts - bank, credit card, etc. - in one place. You just input your information, and the app will help you schedule payments, create and stick to a budget, and much more.
Free for iOS and Android.

PERSONAL CAPITAL: This is like having a financial adviser on your phone. It’s similar to the above two apps, but users report it’s quicker and smoother. It also has fun charts and graphs that let you see your money in new ways.
Free for iOS and Android.

TOSHL: If you want an even more visually fun financial app, check out this one. It uses little monster characters to help your track your finances. You can create budgets, keep track of bills and more.
Free for iOS and Android.

Posted on 9:15 AM | Categories:

14 Top Income Tax Breaks Expiring in ‘14

Ken Berry for CPA Practice Advisor writes: When the ball dropped in Times Square at midnight on New Year’s Eve, it did more than signal the start of another year. It also officially closed the books on several significant tax breaks for individuals and small business owners. Unless these provisions are resurrected by a bipartisan Congress – no sure bet – they won’t be available in 2014.
Appropriately enough, here are 14 top tax breaks that expired on January 1, 2014, although taxpayers may still benefit from them on ’13 returns.
  1. Tuition and fees deduction: In lieu of a higher education tax credit, parents of children in college may deduct qualified tuition and fees expenses. The deduction of either $2,000 or $4,000, which was phased out for upper-income taxpayers, is claimed “above the line,” thereby reducing adjusted gross income (AGI) for other purposes.
  2. State sales tax: A taxpayer can bypass a deduction for state and local income tax in 2013 by choosing to deduct state and local sales tax if that produces a bigger write-off. This tax return option is especially valuable to residents of states with no income tax or relatively low rates.
  3. Charitable rollovers from IRAs: An individual age 70 ½ or over could transfer to  $100,000 directly from an IRA to a charity in 2013 without paying any income tax on the payout. On the flip side, the transfer doesn’t qualify for a charitable deduction, although it counts as a “required minimum distribution” (RMD). Taxpayers age 70 ½ or over must take annual RMDs from their IRAs.  
  4. Qualified small business stock: Under this provision, investors in “qualified small business stock” (QSBS) are allowed to exclude 100% of the gain from the sale of QSBS acquired before 2014. The required holding period is five years. After 2013, the exclusion is limited to 50% of the gain.
  5. Mortgage debt cancellation: Generally, forgiveness or cancellation of a debt results in taxable income, but an exception was previously carved out for homeowners with a mortgage debt canceled due to a foreclosure, short sale or mortgage restructuring. This tax exclusion is only allowed for forgiveness on a debt of up to $2 million on a principal residence.
  6. Mortgage insurance premiums: Also, a homeowner can deduct mortgage insurance premiums paid for a qualified residence (i.e., a principal residence or second home). This writeoff is phased out for an AGI between $100,000 and $110,000. 
  7. Mass transit benefits: For 2013, the tax-free exclusion for mass transit benefits is synced with the benefits for parking allowances at $245 a month. But the tax-free benefit for mass transit benefits drops to $130 per month in 2014, along with the maximum exclusion allowed for commuter highway vehicles.
  8. Residential energy credit: In the latest reincarnation of this tax break, a homeowner could claim a credit of 10% of the cost of energy-saving improvements made in 2013, up to a lifetime maximum of $500. It is uncertain whether Congress will revive this tax benefit once again.   
  9. Section 179 deductions: A business can currently deduct up to $500,000 of qualified property placed in service in 2013, although the maximum deduction is reduced if a $2 million threshold is exceeded. Absent any change, the maximum deduction is scheduled to plummet to $25,000 in 2014 with just a $200,000 reduction threshold.
  10. Bonus depreciation: As icing on the cake, a business could claim a 50% bonus depreciation deduction for qualified property placed in service in 2013, in addition to any Section 179 deduction. Any remainder may be depreciated over the property’s useful life. With limited exceptions, bonus depreciation is gone after 2013.
  11. Fast depreciation writeoffs: A special provision allowed qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements to be depreciated over 15 years for property placed in service in 2013. For 2014, these assets will be depreciated over the usual 39-year period.
  12. Health coverage tax credit: To make health insurance more affordable, a tax credit for 72.5% of health insurance premiums is available to eligible individuals. However, the taxpayer must meet certain requirements, such as paying more than 50% of the premiums to a qualified plan.
  13. Conservation easements: An individual can deduct the value of an easement in property donated for charitable purposes. For 2013, the deduction is limited to 50% of AGI, but it is reduced to the usual figure of 30% of AGI in 2014.
  14. Classroom expenses: Certain educators – including teachers and principals of elementary schools – may deduct up to $250 of their out-of-pocket expenses above-the-line on a 2013 return. For 2014, such deductions are allowed only to the extent they qualify as employee business expenses.
This list is not all-inclusive, but features those tax breaks that are most likely to be significant to clients. Their ultimate fate won’t be determined until Congress returns from recess.
Posted on 9:15 AM | Categories:

Tax implications of selling investment condo at a loss

Ilyce Glink & Samuel Tamkin for Real Estate Matters Chicago Tribune write: Question: I purchased a condominium in 1997 for $78,000 and rented it out shortly after my purchase. I took the standard depreciation during tax filing period each year. The condominium was paid in full in 2004.
Answer: I sold the condo for $60,000 and netted $52,000. I have never sold a property of any kind before this. Bottom line, will I owe any taxes on the $52,000 I received for the sale of the property?

A: At first glance, you look at your situation and think that you have had a loss and shouldn't owe any federal income taxes on the sale. That may still be the case but you'll have to go through the numbers to find out what your tax bill is.

You owned the condominium for about 16 years but sold it that last year. In essence, you were able to depreciate half of the condominium's value. We don't know what value you gave to the condominium to start the depreciation. Usually, when you buy a condominium you are able to take depreciation on the building portion of its value but not the land component.

But if we assume you allocated about 10 percent to the land and 90 percent to the condominium, you were able to depreciate about $35,000 over the years. On the sale of the condominium, the IRS would want you to repay that depreciation benefit at a 25 percent rate or about $8,750. That sum would be due in taxes to the IRS.

You held the property for investment purposes and you're not a professional investor. As such, you may have had losses in your ownership of the condominium during the years you owned it and were not able to take those losses.

On the sale of the condominium, it appears that you have a loss of about $18,000. Given that loss and any other carry-over losses you might have had over the years, you may not have any tax to pay or you'll cut down any taxes you may owe as a result of those losses.

One additional item that you might need to consider, while you sold your condominium for $60,000, you probably also had other expenses that you put into the condominium and the association over the 16 years you owned it.

The money you put into the unit and building -- if any of that money was for capital expenses -- that money would have increased the basis (or cost) of your condominium and increased your loss.

As you can see, it can get rather complicated, even for a real estate investment of $78,000. When the tax preparation programs come out, you can give it try to see what you might owe, or you'll have to talk to a tax specialist to help you fill out the tax forms.
Posted on 9:14 AM | Categories:

IRS Offers Videos to Help Taxpayers Preparing to File in 2014

The Internal Revenue Service is offering taxpayers a number of instructional YouTube videos to help prepare their taxes for the upcoming filing season, which begins on Jan. 31.
Several options are available to help taxpayers prepare for the 2014 tax season and get their refunds as easily as possible. Many software companies are expected to begin accepting tax returns in January and hold those returns until the IRS systems open on Jan. 31. This includes the Free File partners that offer access to their software for free at irs.gov/Free File. The IRS will not process any tax returns before Jan. 31, so there is no advantage to filing on paper before the opening date. Taxpayers will receive their tax refunds much faster by using e-file or Free File with the direct deposit option.
In addition, the IRS has short and informative YouTube videos on a number of tax-related topics in English, Spanish and American Sign Language (ASL). The channels have received nearly 6.5 million views:
Specific videos that taxpayers may view to help them get ready over the coming weeks include:
  • Do-It-Yourself Free Tax Preparation ─ Helps taxpayers find free help from certified volunteers to electronically file tax returns. Taxpayers interested in helping their own communities can also watch a video to learn about becoming involved in the Volunteer Income Tax Assistance or Tax Counseling for the Elderly programs.
  • Do I Have to File a Tax Return? ─ Learn about the requirements for filing a tax return, including income limits and age, and why taxpayers may want to file even if they don't have to.
  • How to Get 1040 Forms ─  Provides tips on the quickest way to get the various 1040 forms on IRS.gov.
  • Tax Scams ─  Offers some tips on how to protect personal information and avoid becoming a tax scam victim.
  • Record-keeping ─  Learn which financial and tax files to keep and how long to keep them.
  • Changed Your Name After Marriage or Divorce? ─  Find out what you need to do if you have changed your name before you file your tax return.
  • Choosing a Tax Preparer ─ Hear some useful tips for choosing a reputable tax preparer.
The IRS uses social media tools and platforms to share the latest information on tax changes, initiatives, products and services. These social media platforms include the IRS2Go phone application, YouTube, Tumblr, Twitter and Facebook. To protect taxpayer privacy, the IRS only uses social media tools to share public information, not to answer personal tax or account questions. It advises taxpayers to never post confidential information, like a Social Security number, on social media sites. A listing is available on IRS.gov.
Posted on 9:08 AM | Categories:

NEW MEDICARE TAXES & AFFORDABLE CARE ACT : Summation of Impact

Effective January 1, 2013, the Affordable Care Act imposed two new Medicare taxes on qualified taxpayers: a 3.8 percent net investment income (NII) tax and a 0.9 percent Additional Medicare Tax. Throughout much of 2013 …and despite proposed reliance regulations issued in 2012, many taxpayers and their advisors continued to have questions regarding the application of these new taxes. Finally, on November 26, 2013 -a full 330 days into the first year in which the two new taxes applied, the IRS released much-anticipated final regulations.

IMPACT.

The final NII tax regulations are intended to clarify many issues, largely in favor of taxpayers, but also defer complete resolution of other questions to guidance promised in 2014. They arrived late enough in the year to foreclose consistent or aggressive strategies for the 2013 tax year.

Net Investment Income Tax. The NII tax on taxpayers (individuals and trusts and estates) equals 3.8 percent of the lesserof: (1) net investment income for the tax year, or (2) the excess, if any of: (a) an individual's modified adjusted gross income (MAGI) for the tax year, over (b) the threshold amount.

The threshold amount is $250,000 in the case of a taxpayer making a joint return or a surviving spouse, $125,000 in the case of a married taxpayer filing a separate return, and $200,000 in any other case (these amounts are not indexed for inflation). The threshold amount for trusts and estates is the start of their 39.6 percent tax bracket, which, for 2013 was $11,950 ($12,150 for 2014).

Final regulations. The November 2013 final regulations retained most provisions from the 2012 proposed reliance regulations, but nevertheless changed several key portions to accommodate what it conceded was legitimate criticism (TD 9644). The final regulations addressed dozens of requests for changes to the 2012 proposed regulations. Some recommendations were adopted, some were tweaked, and some were rejected by the IRS.
Some of the more significant pro-taxpayer changes in the final regulations include:
  • ▪ Allowing Code Sec. 465 net disposition losses to offset other categories of investment income and treating as properly allocable deductions net operating losses allocable to investment income;
  • ▪ Concluding generally that income treated as nonpassive under the Code Sec. 469 passive activity limitations also may qualify as nonpassive under Code Sec. 1411;
  • ▪ Classifying income from self-rented property more favorably;
  • ▪ Providing safe harbors under which some real estate professionals will avoid the NII tax;
  • ▪ Acknowledging that renting out even a single item of property may qualify as a trade or business, depending on facts and circumstances; and
  • ▪ Providing regrouping opportunities on passive activities that apply to Code Sec. 469 in addition to Code Sec. 1411.
New proposed regulations. In response to taxpayer feedback, the IRS issued new proposed reliance regulations at the same time as the final regulations. The proposed reliance regulations are intended to provide, among other things, simplified methods to compute NII vulnerable gain or loss on the sale of pass through entities (NPRM REG130843-13). The proposed reliance regulations address areas that either were not covered in the 2012 proposed regulations, or that the IRS subsequently revised.

Additional Medicare Tax. Final regulations on the Additional Medicare Tax were also released by the IRS in November (TD 9645). The Additional Medicare Tax applies to employee compensation/self-employment income in any tax year beginning after December 31, 2012. The final regulations generally track proposed regulations issued in 2012, with some clarifications.

The IRS acknowledged that the Additional Medicare Tax requires new recordkeeping and withholding procedures for employers. However, the agency declined to give employers additional time to correct errors, allow corrections for a certain period without penalty, or exempt de minimis errors from penalties. The IRS also described correction of overpayments and underpayments by employers in the final regulations.

IMPACT.

Employers should be aware of the requirement that they withhold additional income tax from employees whose wages exceed the threshold for the tax (generally, $200,000). Employers that did not properly withhold for 2013 compensation may expect to be assessed penalties since corrections under the regulations are generally only allowed if made within the same tax year.

AFFORDABLE CARE ACT

When Congress passed the Affordable Care Act in 2010 it delayed the effective dates of many key provisions. Effective January 1, 2014, the individual mandate took effect; however, the Obama administration mitigated the requirements for some individuals as the deadline approached. And the Obama administration delayed the effective date of the employer mandate entirely.

Employer mandate. The IRS issued proposed regulations on the employer mandate in January (NPRM REG-138006-12). The proposed regulations describe an applicable large employer (ALE) for purposes of Code Sec. 4980H, the number of hours of service in a calendar month treated as fulltime, how the requirement would apply to a new employer that is an applicable large employer, and more.

IMPACT.

Under the Affordable Care Act, an ALE with respect to a calendar year is an employer that employed an average of at least 50 full-time equivalent employees on business days during the preceding calendar year. The proposed regulations would treat 130 hours of service in a calendar month as the monthly equivalent of 30 hours of service per week.

Delay. In July, the Obama administration announced that the employer mandate would not apply until 2015. The administration explained that it took this action to give employers additional time to implement reporting requirements underCode Sec. 6056. The IRS subsequently issued transition relief providing that information reporting under Code Sec. 6056(and Code Sec. 6055 for insurers) is optional for 2014.

Individual mandate. The IRS issued proposed regulations on the individual shared responsibility payment requirement (individual mandate) in January (NPRM REG-148500-12). Under the proposed regulations, minimum essential coverage for purposes of the individual mandate includes (not an exhaustive list) qualified employer-sponsored coverage, Medicare, Medicaid, and coverage for veterans and children. Certain individuals are exempt from the requirement to carry minimum essential coverage, such as individuals who experience a short gap in coverage, individuals who are unlawfully present in the U.S., and individuals who are incarcerated. The Obama Administration also grandfathered for 2014 certain additional plans that were being cancelled.

Unlike the employer mandate, the individual mandate in general is not delayed and took effect January 1, 2014. However, individuals will not report any liability for failing to carry minimum essential coverage until they file their 2014 returns in 2015.

Code Sec. 36B credit. Individuals who obtain health insurance coverage through an Affordable Care Act Marketplace after 2013 may be eligible for the Code Sec. 36B credit to offset the cost of coverage. In January, the IRS released final regulations on the Code Sec. 36B premium assistance tax credit (TD 9611). In May, the IRS issued proposed regulations to clarify the meaning of "minimum value" (MV) for purposes of claiming the Code Sec. 36B credit (NPRM REG-125398-12).

The IRS also issued proposed reliance regulations on reporting the Code Sec. 36B credit (NPRM REG-140789-12). Marketplaces will report the level of coverage, advance payments of the credit and more to the IRS.

Marketplaces will provide qualified taxpayers with a written statement that includes this same information on or beforeJanuary 31 of the year following the calendar year of coverage.
The Code Sec. 36B credit has been challenged in litigation. In October, a federal district court declined to dismiss a suit claiming that Congress intended for the Code Sec. 36B credit to be available only when individuals purchase health insurance through a state-established Marketplace (Halbig v. Sebelius, D-D. C., No. 13-00623).

Health insurance fees. In November, the IRS issued final regulations on the application of annual fees to health insurance providers under the Affordable Care Act. The annual fee on covered entities is effective after 2013. The IRS intends to notify each covered entity of the preliminary fee calculation by June 15 of each fee year and the final fee calculation on or beforeAugust 31. The fee must be paid by September 30 of each fee year (TD 9643).

Branded prescription drug fee. The IRS issued guidance on the branded prescription drug fee for the 2014 fee year in August (Notice 2013-51). The IRS explained it will mail each covered entity a paper notice of its preliminary fee calculation for the 2014 fee year by March 3, 2014. The IRS will notify each covered entity of its final fee calculation for 2014 by August 29, 2014.

90-day waiting period. The IRS and the U.S. Departments of Health and Human Services (HHS) and Labor (DOL) issued proposed reliance regulations in March to describe the 90-day limitation for group health insurance under the Affordable Care Act (NPRM REG-122706-12). Insured and self-insured group health plans are generally precluded from imposing a waiting period that exceeds 90-days before coverage can begin for eligible group members.

Compensation. The IRS issued proposed reliance regulations on the $500,000 deduction limitation on compensation provided by health insurance providers under the Affordable Care Act in April (NPRM REG106796-12). The deduction limit applies to a covered health insurance provider in a tax year beginning after December 31, 2012.

Charitable hospitals. In April, the IRS released proposed reliance regulations on the Code Sec. 501(r)(3) requirement that charitable hospitals perform a community health needs assessment (CHNA) every three years or risk losing their tax-exempt status (NPRM REG-106499-12). The IRS issued temporary and proposed regulations in August for charitable hospital organizations on how to report excise taxes and file any excise tax return for failing to meet the CHNA requirements (TD 9629, NPRM REG-115300-13).

Indoor tanning tax. In June, the IRS issued final regulations on the Affordable Care Act's indoor tanning tax when services are bundled (TD 9621). This excise tax generally took effect in 2010.

PCORI. The Affordable Care Act established the Patient-Centered Outcomes Research Institute (PCORI), which is funded by the Patient-Centered Outcomes Research Trust Fund. The trust fund is funded—in part—by fees paid by issuers of certain health insurance policies and sponsors of certain selfinsured health plans. In July, the IRS posted frequently asked questions (FAQs) on its website about the PCORI fees that apply to specified health insurance policies with policy years ending after September 30, 2012, and before October 1, 2019.
IRS Chief Counsel determined in 2013 that the Patient-Centered Outcomes Research Trust Fund fee is deductible underCode Sec. 162(a) (AM 2013-002).

Preventative services. In July, the IRS issued final regulations on the coverage of certain preventative services under the Affordable Care Act (TD 9624). The final regulations generally provide that the requirement to offer coverage for certain preventive services without cost sharing is subject to the religious employer exemption and eligible organization accommodations.

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