Minimize the Tax Bite from Exemption & Itemized Deduction Phase-outs

Tax Attorneys at Ainer & Fraker, LLP Discuss Tax Planning Strategies for Minimizing the Tax Bite from Exemption & Itemized Deduction Phase-outs:

Generally, taxpayers are allowed to deduct personal exemptions of $3,900 for themselves, their spouses and their dependents. In addition, taxpayers are allowed a standard deduction or, if their deductions are large, they can itemize their deductions.

The American Taxpayer Relief Act of 2012 included a provision to phase out, beginning in 2013, both the personal exemptions and itemized deductions for higher income taxpayers. The phase-out will begin when a taxpayer’s adjusted gross income (AGI) reaches a phase-out threshold amount.

The threshold amounts are based on the taxpayers’ filing statuses and are: $250,000 for single filers, $275,000 for individuals filing as heads of households, $300,000 for married couples filing jointly and $150,000 for married individuals filing separately. Here is how the phase-out will work:

  • Personal Exemption—The otherwise allowable exemption amounts are reduced by 2% for each $2,500 or part of $2,500 ($1,250 for a married taxpayer filing separately) that the taxpayer’s AGI exceeds the threshold amount for the taxpayer’s filing status.

Example: Ralph and Louise have an AGI of $412,500 for 2013 and two children for a total of four exemptions totaling $15,600 (4 × $3,900). The threshold for a married couple is $300,000; thus, their income exceeds the threshold by $112,500. Dividing $112,500 by $2,500 equals 45. So 90% (45 × 2%) of their $15,600 exemption allowance is phased out, leaving them with a reduced exemption deduction of $1,560 ((100–90) × $15,600). Assuming Ralph and Louise are in the 33% federal tax bracket, the phase-out costs them an additional $4,633 ($15,600 × 90% × 33%).

Divorced or separated parents subject to the phase-out should consider relinquishing the exemption of a dependent child to the other parent. Where a taxpayer is a party to a multiple support agreement, the taxpayer may want to allow another contributing member of the agreement who is not hit by the phase-out to claim the dependent’s exemption.

  • Itemized DeductionsThe total amount of itemized deductions is reduced by 3% of the amount by which the taxpayer’s AGI exceeds the threshold amount, with the reduction not to exceed 80% of the otherwise allowable itemized deductions.

Not all itemized deductions are subject to phase-out. The following deductions are not subject to the phase-out:

  • Medical and dental expenses
  • Investment interest expenses
  • Casualty and theft losses from personal-use property
  • Casualty and theft losses from income-producing property
  • Gambling losses

Thus, a taxpayer who is subject to the full phase-out still gets to deduct 20% of the deductions subject to the phase-out and 100% of the deductions listed above.

Example: Ralph and Louise from the previous example, who had an AGI of $412,500 for 2013, exceed the threshold for a married couple by $112,500. Thus, they must reduce their itemized deductions subject to the phase-out by $3,375 (3% of $112,500), but the reduction must not exceed 80% of the deductions subject to the phase-out. For 2013, Ralph and Louise had the following itemized deductions:

                                                            Subject to Phase-out     Not Subject to Phase-out

Home mortgage interest:                           $10,000

Taxes:                                                        $8,000

Charitable contributions:                            $6,000

Casualty loss:                                                                                           $12,000

Total:                                                            $24,000                               $12,000

The phase-out is the lesser of $3,375 or 80% of $24,000. Thus Ralph and Louise’s itemized deductions for 2013 will be $32,625 ($24,000 $3,375 + $12,000). Assuming Ralph and Louise are in the 33% federal tax bracket, the phase-out will cost them an additional $1,114 ($3,375 × 33%).

Conventional thinking is to maximize deductions. However, where taxpayers normally are not subject to a phase-out and have a high-income year because of unusual income, it may be appropriate, where possible, to defer paying deductible expenses to the year following the high-income year or perhaps pay and deduct the expenses in the preceding year.

Please Contact a Tax Attorney at Ainer & Fraker, LLP if you have questions about how these phase-outs will impact your specific situation, you want to adjust your withholding or estimated taxes, or you want to make a tax planning appointment

Leave Your Business to Your Family – Not the Government

Tax Attorneys at Ainer & Fraker, LLP Discuss Succession Strategies for the Family Held Business:

Successfully passing a family business to the family upon death of the owner is not an easy task. Most business owners fail to realize the importance of a sound business succession plan. As a result, only about half of all family businesses are transferred to the next generation. A significant number are forced to look elsewhere for capital and management expertise.

Without the benefits of a succession plan, grieving loved ones are forced into a business they know little about, which can adversely affect the financial stability of the business and the financial security of your family. Not only should management succession be addressed in the business succession plan, but transfer of ownership and estate planning issues should also be taken care of as well.

Choosing the successor is one of the biggest challenges in business succession planning. Appraise the individual’s strengths and weaknesses and ensure that the individual has the leadership skills and drive to meet the goals of the business. The needs of the business – not the desires of family members – should be your foremost consideration. It is imperative that a plan is developed in the early stages so that whomever you choose can benefit from your experience and knowledge.

Other crucial elements of a sound business succession plan include transfer of ownership and estate planning. Buy-sell agreements, stock gifting, trusts and wills are some of the ways to transfer ownership. Each of these means of transfer has specific legal and tax ramifications and should be considered in conjunction with proper estate planning.

Please Contact a Tax Attorney at Ainer & Fraker, LLP for assistance with your family’s business succession plan.

Don’t Overlook Form 8594 When Buying or Selling a Business

Tax Attorneys at Ainer & Fraker, LLP Discuss the Use of IRS Form 8594 When Buying or Selling a Business:

Most businesses are made up of different types of assets, and those assets get different treatment for tax purposes. How those items are identified at the time of the sale/purchase can have a significant tax impact on both the buyer and the seller. A seller will, of course, want to designate items into classes that will yield a long-term capital gain on sale and thus provide the best tax result from the sale, whereas the buyer will generally want to designate the purchased items into classes that provide the biggest up-front write-offs.

The IRS generally does not care how the class allocations are made so long as both the buyer and the seller use consistent treatment. That is where IRS Form 8594 comes in. The form allocates the entire purchase/sale price of the business into the various classes of assets; both the buyer and the seller are required to file the form with their tax returns. It is also very important that allocations be spelled out in the sale/purchase agreement and that the treatment between the buyer and seller is consistent.

Generally, assets are divided into the seven categories very briefly described below:

Class I – Cash and Bank Deposits
Class IIActively Traded Personal Property & Certificates of Deposit
Class IIIDebt Instruments
Class IVStock in Trade (Inventory)
Class VFurniture, Fixtures, Vehicles, etc.
Class VIIntangibles (Including Covenant Not to Compete)
Class VIIGoodwill of a Going Concern

A seller would prefer to designate the major portion of the sales price to goodwill and minimize any allocation to furnishings and equipment.

Why, you ask?

Because goodwill is a capital asset, the sale of which for Federal purposes will be taxed at a maximum rate of 20% in 2013, while furnishings and equipment can be taxed as high as 39.6 percent. On the other hand, the buyer would prefer to have as much as possible designated as furnishings and equipment, since they can be expensed or written off over a short period of time (usually 5 or 7 years) as opposed to a 15-year amortized write-off of the goodwill.

Whether you are the buyer or the seller, don’t leave the asset allocations to chance. Negotiate the allocation as part of the sales agreement. If you don’t, you could easily end up with inconsistent treatment and potential adjustments by the IRS.

Please Contact a Tax Attorney at Ainer & Fraker, LLP if you are anticipating a sale or purchase so the transaction can be structured to your best benefit.

ACA Employer Letter Requirement

Tax Attorneys at Ainer & Fraker, LLP Discuss the Affordable Care Act’s Employer Letter Requirement

• Employers must give employees health care notification.
• Affects employers with one or more employees and a gross income of $500,000 or more.
• Notices due October 1, 2013.
• New Employees must be notified within 14 days.

Beginning Oct. 1, any business with at least one employee and $500,000 in annual revenue must notify all employees by letter about the Affordable Care Act’s health care exchanges. The requirement applies to any business regulated under the Fair Labor Standards Act (FLSA), regardless of size. Going forward, letters are to be distributed to any new hires within 14 days of their starting date, according to the Department of Labor.

The Patient Protection and Affordable Care Act has a general $100-per-day penalty for non-compliance. Since this requirement is in the FLSA, concerns were raised in the business community that the $100-per-day penalty would apply to businesses that did not comply with the notification requirements.

On September 12, 2013, the Small Business Administration (sba.gov) posted a blog called “Myth #3: Business Owners Will Be Fined if They Don’t Notify Their Employees about the New Health Insurance Marketplace.”

The article clarifies the policy, stating: “If your company is covered by the FLSA, you must provide a written notice to your employees about the Health Insurance Marketplace by October 1, 2013. However, there is no fine or penalty under the law for failing to provide the notice.”

The Department of Labor provides model notices for employers:
• Employers with plans: http://www.dol.gov/ebsa/pdf/FLSAwithplans.pdf
• Employers without plans: http://www.dol.gov/ebsa/pdf/FLSAwithoutplans.pdf

Please Contact a Tax Attorney at Ainer & Fraker, LLP to help ensure you are in compliance with this law.

VIDEO: Understanding the Medicare Surtax

Tax Attorneys at Ainer & Fraker, LLP Discuss  the Unearned Income Medicare Contribution Tax

As part of the Affordable Care Act (the new health care legislation), a new tax kicks in this year. The official name of this tax is the Unearned Income Medicare Contribution Tax, and even though the name implies it is a contribution, don’t get the idea that it is voluntary or that you can deduct it as a charitable contribution. It is actually a surtax levied on the net investment income of taxpayers in the higher income brackets. And although it is perceived as an additional tax on higher-income taxpayers, it can affect even those who normally don’t have higher income if they have a large income from the sale of real estate, stocks, or other investments.

The surtax is 3.8% on whichever is less: your net investment income or the excess of your modified adjusted gross income (MAGI) over a threshold based on your filing status. Net investment income is your investment income reduced by investment expenses; MAGI is your regular AGI increased by income excluded for working out of the country.

The filing status threshold amounts are:

$250,000 for married taxpayers filing jointly and surviving spouses.
$125,000 for married taxpayers filing separately.
$200,000 for single and head-of-household filers.

Example: A single taxpayer has net investment income of $100,000 and MAGI of $220,000. The taxpayer would pay a Medicare contribution tax only on the $20,000 amount by which his MAGI exceeds his threshold amount of $200,000, because that is less than his net investment income of $100,000. Thus, the taxpayer’s Medicare contribution tax would be $760 ($20,000 × 3.8%).

Investment income includes:

Interest, dividends, annuities (but not distributions from IRAs or qualified retirement plans), and royalties,
Rents (other than derived from a trade or business),
Capital gains (other than derived from a trade or business),
Home-sale gain in excess of the allowable home-gain exclusion,
A child’s investment income in excess of the excludable threshold if, when eligible, the parent elects to include the child’s investment income on the parent’s return,
Trade or business income that is a passive activity with respect to the taxpayer, and
Trade or business income with respect to trading financial instruments or commodities.

Planning Note: For surtax purposes, gross income doesn’t include interest on tax-exempt bonds. Thus, one can avoid or reduce the net investment income surtax by investing in tax-exempt bonds.

Investment expenses include:

Investment interest expense,
Investment advisory and brokerage fees,
Expenses related to rental and royalty income, and
State and local income taxes properly allocable to items included in Net Investment Income.

Do you think you will never get hit with this tax because your income is way under the threshold amounts? Don’t be so sure. When you sell your home, the gain is a capital gain, and to the extent that the gain is not excludable using the home-gain exclusion, it will add to your income and possibly push you above the taxation thresholds. And, since capital gains are investment income, you might be in for a surprise. The same holds true for gains from selling stock, a second home, or a rental. So when planning to sell a capital asset, be sure to consider the impact of this new surtax.

The surtax also applies to the undistributed net investment income of trusts and estates, and there are special rules applying to the sale of partnership and Sub-S Corporation interests.

Example: A taxpayer has owned a residential rental property for a number of years, planning to use the rental’s increased value to help fund his retirement. The taxpayer normally has income well below the threshold for this new tax. The taxpayer sells the rental and has a substantial gain. The gain from the rental sale gives the taxpayer a one-time windfall that pushes his income above the threshold for the new tax, and he ends up having to pay the regular capital gains tax plus an additional 3.8% tax on the appreciation that is attributable to the increase in value that occurred over several years.

If this surtax will apply to you in 2013, you may need to increase your income tax withholding or estimated tax payments to cover the additional tax so you can avoid or minimize an underpayment of estimated tax penalty when you file your 2013 return.

Example: A taxpayer has owned a residential rental property for a number of years, planning to use the rental’s increased value to help fund his retirement. The taxpayer normally has income well below the threshold for this new tax. The taxpayer sells the rental and has a substantial gain. The gain from the rental sale gives the taxpayer a one-time windfall that pushes his income above the threshold for the new tax, and he ends up having to pay the regular capital gains tax plus an additional 3.8% tax on the appreciation that is attributable to the increase in value that occurred over several years.

Please Contact a Tax Attorney at Ainer & Fraker, LLP to explore your options to mitigate the impact of the tax.

Essential Tax Requirements Of Giving Money To Charity

In addition to considering the Advantages and Disadvantages of Bequests and Outright Gifts, it is necessary to examine some of the legal and tax requirements required by the Internal Revenue Service and State taxing authorities:

Organization Must Qualify to Receive Charitable Contributions – IRS Publication 526 provides guidance as to what sorts of organizations are qualified to receive charitable contributions. While this may seem evident, it is the Donor who will inevitably bear the burden if a donee organization ends up not to qualify.

Proper Documentation Must be Filed with the IRS – Donors may only deduct a charitable contribution that exceeds $250.00 if he or she receives an Acknowledgment from the qualified organization or certain payroll deduction records. If more than one gift exceeding $250.00 is made, a Donor must receive either separate acknowledgments for each gift that exceeds $250.00 or one verification that shows their total contributions.

Fair Market Value of the Donated Property must be Ascertained – For cash or publicly traded securities, this requirement is reasonably straightforward to carry out. Less clear, however, can be the fair market value of assets that are more difficult to evaluate (i.e. works of art, real estate, etc).

More sophisticated giving strategies also involve tax and legal requirements.

As a result of the serious nature of these requirements, we regularly highly recommend seeking qualified legal counsel to assist you when making donations over $250.00.

For additional guidance and requirements, refer to these IRS Publications:

IRS Publication 561: Determining the Value of Donated Property

IRS Publication 526: Charitable Contributions

Strategic Tax Planning for Capital Gains and Losses

Tax Attorneys at Ainer & Fraker, LLP Discuss the Strategic Tax Planning Options for Capital Gains and Losses.

Year-end has historically been a good time to plan tax savings by carefully structuring capital gains and losses.  Conventional wisdom has always been to minimize gains by selling “losers” to offset gains from “winners,” and where possible, generate the maximum allowable $3,000 capital loss for the year.

Long-term capital losses offset long-term capital gains before they offset short-term capital gains. Similarly, short-term capital losses offset short-term capital gains before they offset long-term capital gains. (“Long-term” means that the stock or property has been held over one year.) Keep in mind that taxpayers may use up to $3,000 of total capital losses in excess of total capital gains as a deduction against ordinary income in computing adjusted gross income or AGI.  Individuals are subject to federal income tax at a rate as high as 39.6% on short-term capital gains and ordinary income. But long-term capital gains are generally taxed at a maximum rate of 15% or 20%.

All of this means that having long-term capital losses offset long-term capital gains should be avoided where possible, since those losses will be more valuable if they are used to offset short-term capital gains or ordinary income. Avoiding this requires making sure that the long-term capital losses are not taken in the same year as the long-term capital gains. However, this is not just a tax issue; investment factors also need to be considered. It would not be wise to defer recognizing gain until the following year if there is too much risk that the property’s value will decline before it can be sold. Similarly, one wouldn’t want to risk increasing a loss on property that is expected to continue declining in value by deferring its sale until the following year.

To the extent that taking long-term capital losses in a different year than long-term capital gains is consistent with good investment planning, a taxpayer should take steps to prevent those losses from offsetting those gains.

  • Increased Capital Gains Rates – The special long-term capital gains rates that have been in effect since 2003 are revised as of 2013and for future years without Congressional tinkering. The capital gains rates are now 0% to the extent your marginal tax rate is 10% or 15% and 15% to the extent your marginal rate is between 25% and 35%. This means that the 15% capital gains rate will apply for individuals who file the single status with taxable income in 2013 between $36,251 and $400,000. The 15% capital gains rate for married couples filing jointly will be in effect if their 2013 taxable income is between $72,501 and $450,000. For higher income taxpayers – those in the 39.6% tax bracket – the capital gains rate increases to 20%.

    Individuals with large long-term capital gains in their investment portfolios might consider taking a profit up to the amount that would be taxed at 0%. The good news here is that the wash sale rules do not apply to assets sold at a gain. So if you like a stock, you are free to buy it back right away. If your state doesn’t have a lower tax rate on capital gains, then the additional state tax you’d pay from selling profitable capital assets will need to be weighed against the federal tax you’d potentially save when deciding whether to make tax sales before year-end.

  • Increased Marginal Tax Rates – Beginning in 2013 the marginal rates are 10, 15, 25, 28, 33, 35 and 39.6 percent (up from 10, 15, 25, 28, 33 and 35 percent). These rates apply to “ordinary” income including short-term capital gains.

    Conventional wisdom has always been to defer income, but depending upon your tax bracket and future income you anticipate, it may be appropriate to consider accelerating income to take advantage of a lower tax rate.

It may be in your best interest to review youy current year tax strategy with an eye to the future to maximize your benefits from gains or losses associated with capital assets.

Please Contact a Tax Attorney at Ainer & Fraker, LLP to discuss Strategic Tax Planning options for Capital Gains and Losses.

Tax Credit for Small Employer Health Insurance Premiums

Tax Attorneys at Ainer & Fraker, LLP Discuss the Tax Credit for Small Business Employer Health Insurance Premiums:

The tax law provides a credit for small business employers in 2010, 2011, 2012, and 2013 that pay the health insurance premiums for their low- to moderate-income workers. This refundable credit can be as much as 35% of the insurance premiums paid by the employer.

To qualify for the credit, the employer can’t have more than 25 full-time equivalent employees, and the average wage of the employees cannot exceed $50,000 for the year. The 25 full-time equivalent employee limit is computed by taking into account both full-time and part-time employees for the year using a formula.

To see if your firm may qualify for the credit, complete the two worksheets below – the results at lines 6 and 9 will tell you if your firm is under the maximum full-time equivalent employee and average wage limitations.

Determine the Number of Full-Time Equivalent Employees:

1. Enter the number of employees who worked 2,080 hours or more during the year:

2. Multiply line 1 by 2,080:

3. Enter the total hours worked by all employees who worked less than 2,080 hours during the year:

4. Enter the total of lines 2 and 3:

5. Divide the result on line 4 by 2,080:

6. Number of full-time equivalent employees (round line 5 down to the next whole number, unless the number is less than one, in which case enter 1:
If line 6 is greater than 25, stop – your firm does not qualify for this credit.

Determine the Average Annual Wage:

7. Enter the total of all wages paid to employees during the tax year:

8. Divide line 7 by the number of full-time equivalent employees (line 6):

9. Average annual wage (round amount from line 8 down to the next whole $1,000):
If the amount on line 9 is $50,000 or less, you may qualify for the credit. Besides meeting the limits of lines 6 and 9, to qualify for the credit an employer has to contribute at least 50% of the premiums for the employees’ health insurance coverage on a uniform basis. However, for tax years beginning in 2010 only, an employer can meet this requirement even if it pays differing percentages of different employees’ premiums as long as all employer payments are at least 50% of each employee’s premium based on single (employee-only) coverage.

The amount of the credit gradually phases out if the number of full-time equivalent employees exceeds ten or if the average annual wage of the employees exceeds $25,000. Under the phase-out, the full amount of the credit is available only to an employer with ten or fewer full-time equivalent employees and whose employees have average annual wages of less than $25,000.

Please Contact a Tax Attorney at Ainer & Fraker, LLP if you have questions related to this credit or determining whether your firm can benefit from claiming the credit.

Internal Revenue Service Tax Requirements Of Donating Money To Charity

In addition to considering the Advantages and Disadvantages of Bequests and Outright Gifts, it is essential to examine some of the legal and tax requirements exacted by the IRS and State taxing authorities:

Organization Must Qualify to Receive Charitable Contributions – IRS Publication 526 provides instruction as to what kinds of organizations are allowed to receive charitable contributions. While this may seem self evident, it is the Donor who will subsequently bear the burden if a donee organization turns out not to qualify.

Proper Documentation Must be Filed with the Internal Revenue Service – Donors may only deduct a charitable contribution that exceeds $250.00 if he or she is given an Acknowledgment from the qualified organization or certain payroll deduction records. If more than one gift exceeding $250.00 is made, a Donor must be given either separate acknowledgments for each gift that exceeds $250.00 or one acknowledgment that shows their total contributions.

Fair Market Value of the Donated Property must be Assessed – For cash or publicly traded securities, this requirement is rather simple to carry out. Less clear, however, can be the fair market value of assets that are more difficult to evaluate (i.e. works of art, real estate, etc).

More cutting edge giving techniques also involve tax and legal requirements.

Because of the the important nature of these requirements, we regularly encourage seeking qualified legal counsel to assist you when making donations over $250.00.

For further guidance and requirements, check with these IRS Publications:

IRS Publication 561: Determining the Value of Donated Property

IRS Publication 526: Charitable Contributions