IRS To Accept Tax Returns with Education Credits, Depreciation Next Week

IRS will finally start accepting education credits such as American Opportunity and Hope. Here is the full story:

WASHINGTON — The Internal Revenue Service announced today that taxpayers will be able to start filing two major tax forms next week covering education credits and depreciation. Starting Sunday, Feb. 10, the IRS will start processing tax returns that contain Form 4562, Depreciation and Amortization. And on Thursday, Feb. 14, the IRS plans to start processing Form 8863, Education Credits. This step clears the way for almost all taxpayers to start filing their tax returns for 2012. These forms affected the largest groups of taxpayers who weren’t able to file following the Jan. 30 opening of the 2013 tax season. The IRS will be able to accept the education credits and depreciation forms following the completion of reprogramming and testing of its systems.  Work continues on preparing IRS systems to accept the remaining tax forms affected by the American Taxpayer Relief Act (ATRA) enacted by Congress on Jan. 2. The IRS also announced today it will start accepting the remaining forms affected by the January legislation the first week of March.  A specific date will be announced later. Most of those in this group file more complex tax returns and typically file closer to the deadline or obtain an extension. A full list of the forms that will be accepted the first week of March is available on IRS.gov. Next week’s opening covers two groups of taxpayers using:

• Form 8863, Education Credits. Form 8863 is used to claim two higher education credits -- the American Opportunity Tax Credit and the Lifetime Learning Credit.

• Form 4562, Depreciation and Amortization. Most of the people using the depreciation form tend to file later in the tax season or obtain a six-month extension. Non-1040 business filers using Form 4562 can also file starting Sunday.

For taxpayers using e-file, most software companies are now accepting tax returns with these two forms and will submit them after the IRS begins accepting them next week. More information is available on this website.

Late Start for I.R.S. 2012 Income Tax Processing

Bad news coming out of the IRS today. The IRS will not start processing 2012 Income Tax Returns until January 30th, 2013.

Here is the article from the IRS:

IRS Plans Jan. 30 Tax Season Opening For 1040 Filers

IR-2013-2, Jan. 8, 2013
WASHINGTON — Following the January tax law changes made by Congress under the American Taxpayer Relief Act (ATRA), the Internal Revenue Service announced today it plans to open the 2013 filing season and begin processing individual income tax returns on Jan. 30.
The IRS will begin accepting tax returns on that date after updating forms and completing programming and testing of its processing systems. This will reflect the bulk of the late tax law changes enacted Jan. 2. The announcement means that the vast majority of tax filers — more than 120 million households — should be able to start filing tax returns starting Jan 30.
The IRS estimates that remaining households will be able to start filing in late February or into March because of the need for more extensive form and processing systems changes. This group includes people claiming residential energy credits, depreciation of property or general business credits. Most of those in this group file more complex tax returns and typically file closer to the April 15 deadline or obtain an extension.
“We have worked hard to open tax season as soon as possible,” IRS Acting Commissioner Steven T. Miller said. “This date ensures we have the time we need to update and test our processing systems.”
The IRS will not process paper tax returns before the anticipated Jan. 30 opening date. There is no advantage to filing on paper before the opening date, and taxpayers will receive their tax refunds much faster by using e-file with direct deposit.
“The best option for taxpayers is to file electronically,” Miller said.
The opening of the filing season follows passage by Congress of an extensive set of tax changes in ATRA on Jan. 1, 2013, with many affecting tax returns for 2012. While the IRS worked to anticipate the late tax law changes as much as possible, the final law required that the IRS update forms and instructions as well as make critical processing system adjustments before it can begin accepting tax returns.
The IRS originally planned to open electronic filing this year on Jan. 22; more than 80 percent of taxpayers filed electronically last year.
Who Can File Starting Jan. 30?
The IRS anticipates that the vast majority of all taxpayers can file starting Jan. 30, regardless of whether they file electronically or on paper. The IRS will be able to accept tax returns affected by the late Alternative Minimum Tax (AMT) patch as well as the three major “extender” provisions for people claiming the state and local sales tax deduction, higher education tuition and fees deduction and educator expenses deduction.
Who Can’t File Until Later?
There are several forms affected by the late legislation that require more extensive programming and testing of IRS systems. The IRS hopes to begin accepting tax returns including these tax forms between late February and into March; a specific date will be announced in the near future.
The key forms that require more extensive programming changes include Form 5695 (Residential Energy Credits), Form 4562 (Depreciation and Amortization) and Form 3800 (General Business Credit). A full listing of the forms that won’t be accepted until later is available on IRS.gov.
As part of this effort, the IRS will be working closely with the tax software industry and tax professional community to minimize delays and ensure as smooth a tax season as possible under the circumstances.
Updated information will be posted on IRS.gov.

More information here.

Hot Springs Arkansas Tax Preparation FAQ

Question: Can the tax preparation fee be taken out of my return or do I need to pay for the service upfront?

Both. We can either accept payment when filing or can have the payment deducted from your return.

Question: When is the first day that we can file an income tax return in 2013?

It really depends on the forms you will need. The I.R.S. has given dates for some forms and other forms are expected to be out around the same time.

Federal Forms  
Form 1040A  Individual Tax Return01/10/2013
Form 2441  Child & Dependent Care Expenses01/10/2013  
Schedule 8812  Child Tax Credit01/10/2013  
Schedule EIC  Earned Income Credit01/03/2013

So from reading this, it can be said that the 10th of January will be the first day that we will be able to efile your income tax forms.

Question: When will my return be direct deposited or a check mailed to me if I efile?

The I.R.S. hasn't given out much detail about their schedule but we have used prior years I.R.S. Tax Calendar and modified it using the information that we have received from the I.R.S. so far. To view the I.R.S. 2013 Income Tax Payment Schedule, click here.

Question: How much will I get back from my return?

That is entirely dependent on your personal factors including your income and tax payments for 2012. You're personal situation can also affect this great. HR Block created a great tool for getting an estimate of your tax refund. It is simple, so if you have more advanced taxes, it is most likely incorrect. You can calculate your 2012 Income Tax Return by clicking here.

Question: How do I signup or become a client of Hot Springs Tax Services?

We consider your privacy to be our #1 priority, so we only accept new clients via phone call and in person. This way we can very the individual and avoid any chance of fraud. Feel free to contact us via email to set up consultation or give us a call.

If we missed your question, feel free to comment and we will get it posted up!

Thanks for your time.

Have a great day!

-Hot Springs Tax Services Staff

IRS Update for 2013

Good day,
      I received an email update last night from the Internal Revenue Service. They have changed the first day that they will process returns to the 22nd of January. I updated the IRS payment schedule. It also stated:

Form		Available to File
Federal Forms
Child Tax Cr		01/10/2013
Form 1040A
Individual Tax Return		01/10/2013
Form 2441
Child & Dependent Care Expenses		01/10/2013
Schedule 8812
Child Tax Credit		01/10/2013
Schedule EIC
Earned Income Credit		01/03/2013

You are probably asking yourself right now, what do this mean to me? It means that if you need any of these forms filed, it will actually be on these days before your return can be e-filed. The electronic version of these forms will not be available until the dates listed.
We can still prepare your return and just will have to process it on these dates. It is still possible to recieve your return by the end of January 2013.
Contact us today to schedule an appointment. All you need is your last pay stub from 2012 and your 2011 tax forms.
Taxes@HotSpringsTaxServices.com
(501) 216-0587

Tax Rate Changes to Take Affect January 1st 2013

Much has been written about changes to the estate and gift tax law scheduled to occur on January 1, 2013, particularly the reduction of the lifetime estate and gift tax exemption amount from its 2012 level of $5,120,000 to $1 million. The exemption for the generation-skipping transfer tax will also decrease from its 2012 level of $5,120,000 to a base level of $1 million. It is indexed for inflation from 2001, however, and is currently estimated to be $1,430,000. Significant changes to the income tax law are also scheduled to take effect at the same time, but these changes are only now beginning to receive similar attention. While Congress could still act to avert some or all of the changes, the divided nature of this Congress makes the prospect of any action before January 1, 2013, uncertain. This alert summarizes the most significant of the changes to the income tax law that will take effect on January 1, 2013, and suggests some steps you might consider to mitigate their impact.

Tax Rates

The maximum federal income tax rate on ordinary income will increase from its present level of 35 percent to 39.6 percent. The tax rate on long-term capital gain income will increase from its present level of 15 percent to 20 percent. The most dramatic increase will be to the rate at which qualified dividends are taxed. Qualified dividends are currently taxed at the same 15 percent rate as long-term capital gain income. Beginning January 1, 2013, dividends will be treated the same as other ordinary income and taxed at a maximum income tax rate of 39.6 percent.

Additional Medicare Taxes

Now that the U.S. Supreme Court has upheld the Patient Protection and Affordable Care Act of 2010, the additional Medicare taxes will take effect January 1, 2013, as planned, unless Congress acts to change them.

Employees currently pay a Medicare hospital insurance tax of 1.45 percent on their wages. Self-employed individuals pay 2.9 percent of net earnings from self-employment. Unlike taxes on wages and self-employment income for Old Age, Survivors and Disability Insurance, which are capped, the Medicare component of the social security tax has no ceiling. Beginning January 1, 2013, an additional 0.9 percent tax will apply to wages in excess of $250,000 for a married person filing a joint return ($125,000 for married persons filing separately) or $200,000 for an unmarried individual. This will make the total Medicare tax for these individuals 2.35 percent on their wages above the threshold amount. For self-employed individuals, the additional 0.9 percent will apply to their earnings from self-employment in excess of $250,000 for a married person filing a joint return ($125,000 for married persons filing separately) or $200,000 for an unmarried individual. The total Medicare tax for these individuals will be 3.8 percent on their earnings above the threshold amounts, which are not currently indexed for inflation.

Medicare Tax on Investment Income

A new Medicare tax on net investment income will also take effect beginning January 1, 2013. The rate for this new tax will be 3.8 percent and will apply to the lesser of an individual's i) net investment income; or ii) the excess of the individual's "modified adjusted gross income" over $250,000 in the case of a married couple filing a joint return ($125,000 for married persons filing separately or an unmarried individual). Modified adjusted gross income is the adjusted gross income increased by the amount of the foreign earned income exclusion. For most taxpayers, their modified adjusted gross income will be the same as their adjusted gross income. The threshold amounts are not currently indexed for inflation.

In the case of an estate or trust that accumulates part of its income, the tax will apply to the lesser of i) its undistributed net investment income; or ii) the excess of its adjusted gross income over the dollar amount at which the highest tax bracket in Section 1(e) begins for the taxable year. This amount currently is scheduled to be $7,500. Since this is a much lower threshold amount than applies to individuals, in many cases, net investment income may be subject to the Medicare tax if it accumulated at the trust level, while it would not be subject to the tax if it is distributed to beneficiaries whose adjusted gross income is less than $250,000 if they file a joint return, or $200,000 if they are unmarried.

Net investment income is gross investment income reduced by those allowable deductions that are properly allocable to such income. Investment income includes interest, dividends, annuities, royalties, and rents, provided that this income is not derived from a trade or business that is not a passive activity for the taxpayer. It also includes gains from the disposition of property, so capital gains realized on the sale of appreciated investments will be subject to this new tax, as well as income derived from the business of trading financial instruments or commodities. If a business that is a passive activity for the taxpayer earns any of the above types of income, that income is also subject to the tax.

The tax does not apply to amounts distributed from qualified retirement plans. It also does not apply to any amount that is subject to the self-employment tax. This rule prevents the Medicare tax from applying twice to the same income. While income from a trade or business that is not a passive activity of the taxpayer will not be subject to the 3.8 percent Medicare tax on investment income, much of that income may be subject to the 3.8 percent Medicare tax on self-employment income. Some limited types of income may not be subject to either tax, but a lot of the detail on how the new tax will apply is still missing.

Phase-out of Itemized Deductions and Personal Exemptions

The phasing out of itemized deductions will also return to the tax law in 2013. Once again, an amount of a taxpayer's itemized deductions equal to 3 percent of adjusted gross income in excess of $100,000 (adjusted for inflation) will be disallowed, but not in excess of 80 percent of the taxpayer's total itemized deductions. The disallowance rule applies to all of a taxpayer's itemized deductions except for medical expenses, investment interest, and casualty and theft losses. For 2009, the last year to which the phase-out previously applied, the $100,000 amount had been inflation adjusted to $166,800. The amount for 2013 should be announced soon.

The personal exemption deduction of $3,700 (2011 amount) per taxpayer and dependent will once again be phased out. The deduction is phased out at the rate of 2 percent of the deduction for each $2,500 by which the taxpayer's adjusted gross income exceeds a threshold amount. The amount is inflation adjusted and for 2009, the last year to which the phase-out applied, was $250,200 for taxpayers filing a joint return. The deductions were completely lost if the taxpayer's adjusted gross income exceeded $372,700. The deduction amount and the threshold amount where the phase-out begins for 2013 should be announced soon.

What Should You Do to Prepare for 2013?

You should be prepared to take certain steps after the November elections and before the end of the year if it becomes apparent that Congress will not act to extend the current tax regime into 2013. Some of the considerations are described below.

Should You Sell Appreciated Capital Assets in 2012?

The idea of selling appreciated capital assets in 2012 and paying a federal tax of 15 percent, as compared to a tax of 23.8 percent after 2012, certainly has appeal, since the applicable rate is increasing by 58.67 percent of its present level. Even if you do not wish to part with a particular position, in the case of publicly traded securities, you can easily re-base an appreciated securities position by selling it and then buying the same security. No "wash gain" rule comparable to the wash sale rule for losses applies, and you can sell an asset at a gain today and buy the same asset tomorrow.

Whether this strategy will prove to be a winner over time, however, depends on a number of factors that often are difficult to quantify. Selling earlier than you otherwise would have sold means paying the resulting tax sooner, and once you pay the tax, that money no longer generates further returns for you. By keeping the amount you would have paid in taxes invested on a pre-tax basis, you might eventually generate enough additional return to offset the higher tax rate, or more.

You can model various scenarios, but the result the model generates will only be as accurate as the assumptions you build into it. You will need to predict the time you would otherwise sell the asset, how much the asset might appreciate between now and that time, and the tax rate that might apply. You must also take into account the transaction costs of selling and re-establishing the position. Taxpayers who are elderly or in failing health may want to hold appreciated positions because a basis increase to fair market value at death will still apply.

At the extremes, you can pretty easily determine what to do. For example, if you have a substantially appreciated stock position that you believe you would normally sell in 2013, it almost certainly will be advantageous to sell that holding in 2012. On the other hand, if you have a position that you expect to hold for 15 more years, you are most likely better off just keeping the position and not reducing your invested assets by paying tax now. Over a period of 15 years, by keeping the amount of tax you would pay now invested and generating additional return, you will most likely earn enough to pay the increased amount of income tax that will be due at the time you do sell the asset. You also need to consider the most effective use of capital loss carryovers you might have.

Between these extreme cases, however, the analysis becomes more difficult. The future holding period of the asset and the future return on it are inversely correlated. As the asset's future rate of return increases, the additional time that the asset must be held to overcome the higher tax rate decreases. As a rule of thumb, you might at least consider re-basing positions that you expect to sell within the next five years, and we are available to assist you in evaluating specific situations. Also, do not forget that the early payment of any applicable state income taxes will further diminish the amount of your invested capital going forward.

Many people have done quite well by operating on a philosophy that says the future is uncertain and you should never pay any tax until you absolutely must, a reasonable position to adopt in many cases.

Do Dividend-yield Stock Portfolios Still Make Sense?

If your investment portfolio is significantly weighted in favor of high-dividend-paying stocks, you should probably ask your investment advisor whether this strategy continues to make sense for you in an environment where the tax rate on dividends is nearly three times what it was when the portfolio was established. While a greater emphasis on growth stocks or other asset classes may be appropriate, you should make that decision only after a discussion with your investment advisor.

Should You Accelerate Ordinary Income?

The acceleration of ordinary income into 2012 could have certain advantages. The 2012 maximum federal income tax rate on ordinary income is 35 percent, as compared to the 2013 rate of 39.6 percent, or 43.4 percent if the income is investment income subject to the 3.8 percent Medicare tax on net investment income. Having a higher adjusted gross income in 2012 and a comparatively lower adjusted gross income in 2013 may also ameliorate to some degree the impact of the itemized deduction phase-out that will apply again in 2013. Acceleration of income is even more attractive if you will be paying AMT (Alternative Minimum Tax) in 2012 and can recognize additional ordinary income subject to a 28 percent tax rate.

If you have discretion to accelerate a bonus or other earned income into 2012 instead of 2013, you can also avoid the 0.9 percent increase in the Medicare tax on wages or net earnings from self-employment that will occur in 2013.

If you are able to control the payment of dividends by a "C" corporation or an "S" corporation that has accumulated earnings from prior "C" corporation years, it may be advantageous to pay dividends in 2012 while the federal income tax rate is 15 percent, as compared to 2013 and later years when the rate may be as high as 43.4 percent.

Consider Roth IRA Conversions

It may also be worthwhile to visit or re-visit the subject of Roth IRA conversions before the end of 2012. The maximum income tax rate that will apply to the taxable amount of a Roth conversion in 2012 is 35 percent, as compared to 39.6 percent if the conversion occurs in 2013 or later. While income from a qualified retirement account is not subject to the 3.8 percent Medicare tax on net investment income, the income from the conversion will increase your adjusted gross income. In 2013 or later, if a Roth conversion causes your adjusted gross income to increase from an amount below $250,000 (on a joint return) to an amount above $250,000, the conversion will result in at least a part of your net investment income becoming subject to the Medicare tax. A Roth conversion after 2012 will also result in an additional disallowance of itemized deductions, since that disallowance also increases as your adjusted gross income increases.

What about Itemized Deductions?

Whether you are better off accelerating or deferring itemized deductions is somewhat complicated. Superficially, deferring discretionary payments (e.g., many charitable contributions and some state income taxes) from 2012 to 2013 makes sense because the deduction may result in greater tax savings due to the higher tax rate that will apply in 2013. The phase-out of itemized deductions will also have an impact, however. If a significant portion of the deduction would be disallowed under the phase-out rules in 2013, then you may be better off taking the deduction in 2012, albeit against a lower tax rate. In the case of charitable contributions, another risk of deferring contributions to 2013 is that Congress could always eliminate the deduction at fair market value for contributions of appreciated property. Certain itemized deductions, such as state income taxes, are not deductible for purposes of computing the AMT, so you are better off paying those kinds of expenses in a year where you have less exposure to the AMT.

Conclusion

While other changes to the income tax law also will take effect in 2013, the ones summarized above are the most significant for higher-income taxpayers. If you would like our assistance in evaluating your particular situation and determining your best course of action, please feel free to contact us.

2013 Income Tax Update

Overview

This may be the final year that the so-called Bush tax cuts remain in effect, unless Congress acts to further extend them. The Bush tax cuts, enacted in 2001 and 2003, were originally scheduled to expire for tax years beginning in 2011. However, President Obama signed legislation in late 2010 that temporarily extended the Bush tax cuts through 2012.

Many commentators agree that Congress is unlikely to extend the Bush tax cuts prior to the November elections, but uncertainty remains as to whether Congress will take action following the elections. Provided that Congress fails to extend the Bush tax cuts, many significant rate changes and other substantive changes will take effect in 2013. This article summarizes the major federal income tax changes that are scheduled take effect in 2013 if Congress allows the Bush tax cuts to expire, certain other changes scheduled to take effect independent of the Bush tax cuts, and planning strategies to reduce the impact of these changes. If you or your company would like to discuss any of these scheduled changes or planning strategies, please contact any member of the Tax and Employee Benefits Team.

Individual Income Tax Rates

If Congress allows the Bush tax cuts to expire, ordinary income tax rates will increase for most individual taxpayers beginning in 2013. As discussed below, qualified dividend income that is currently taxed at long-term capital gain rates will be taxed at these higher ordinary income rates. The following table sets forth the scheduled rate increases, using 2012 dollar amounts which will be adjusted for inflation in 2013.

Tax Brackets (2012 Dollar Amounts)				Marginal Rate
Unmarried Filers		Married Joint Filers
Over	But Not Over	Over	But Not Over	2012	2013
$0	$8,700	$0	$17,400	10%	15%
8,700	35,350	17,400	70,700*	15%	15%
35,350	85,650	70,700*	142,700	25%	28%
85,650	178,650	142,700	217,450	28%	31%
178,650	388,350	217,450	388,350	33%	36%
388,350	...	388,350	...	35%	39.6%

* In 2013, this dollar amount will decrease to 167% of the amount for unmarried taxpayers in the same bracket (which is $58,900 in 2012), rather than 200% of the amount for unmarried taxpayers under current law. This change will have the effect of putting more middle-income joint filers in the 28% bracket and increasing the "marriage penalty" for many taxpayers.

Long-Term Capital Gain Rates

The maximum rate on long-term capital gain is scheduled to increase from 15 to 20 percent in 2013. Individual taxpayers in the 10 and 15 percent ordinary income tax brackets currently pay no tax on long-term capital gain. These taxpayers are scheduled to be subject to a 10 percent long-term capital gain rate in 2013. An 18 percent maximum rate will apply to capital assets purchased after 2000 and held for more than five years. Additionally, the 3.8 percent Medicare contribution tax discussed below will increase the effective rate of tax on long-term capital gains for certain higher-income taxpayers to as high as 23.8 percent. The following table sets forth the scheduled rate increases.

Maximum Rates	2012	2013	2013 (including Medicare contribution tax)
Long-Term Capital Gain	15%	20%	23.8%
Qualified 5-Year Capital Gain	15%	18%	21.8%

Planning Strategies. If Congress fails to take action as the year-end approaches, investors who were otherwise considering selling appreciated stocks or securities in early 2013 should give additional consideration to selling in 2012 to take advantage of the lower rate, assuming they will have held the asset for longer than one year. Additionally, business owners who are considering selling their business in the near future should consult with their tax adviser to discuss whether electing out of the installment method for an installment sale in 2012 would be more advantageous from a tax planning perspective.

Dividend Income Rates

The Bush tax cuts created the concept of "qualified dividend income," which currently allows dividends received from domestic corporations and certain foreign corporations to be taxed at the taxpayer's long-term capital gain rate. Additionally, qualified dividend income earned by mutual funds and exchange-traded funds may be distributed to shareholders and treated as qualified dividend income by the shareholder. Prior to the Bush tax cuts, all dividend income was taxed as ordinary income. If Congress fails to extend these provisions, the qualified dividend income provisions will expire, and all dividends will once again be taxed as ordinary income. Most notably, taxpayers in the highest marginal income tax bracket who currently enjoy the 15 percent rate on qualified dividend income will be taxed at 39.6 percent for dividends received from the same issuer in 2013. Additionally, the 3.8 percent Medicare contribution tax discussed below will increase the effective rate of tax on dividend income for certain higher-income taxpayers to as high as 43.4 percent. The following table sets forth the scheduled rate increases.

Maximum Rates	2012	2013	2013 (including Medicare contribution tax)
Qualified Dividend Income	15%	39.6%	43.4%
Ordinary Dividend Income	35%	39.6%	43.4%

Planning Strategies. Because of the impending increase to tax rates applicable to dividends, owners of closely held corporations should consider declaring and paying a larger-than-normal dividend this year if the corporation has sufficient earnings and profits. Owners should carefully plan any such distributions, as distributions in excess of the corporation's earnings and profits will reduce the shareholder's stock basis and subject the shareholder to increased long-term capital gain taxable at potentially higher rates when the shareholder subsequently disposes of the stock. Owners of closely held corporations should consult their tax adviser to discuss dividend planning and other strategies such as leveraged recapitalizations to take advantage of the low rate currently applicable to qualified dividend income.

New Medicare Contribution Tax

A new 3.8 percent Medicare contribution tax on certain unearned income of individuals, trusts, and estates is scheduled to take effect in 2013. This provision, which was enacted as part of the Patient Protection and Affordable Care Act (PPACA), is scheduled to take effect regardless of whether Congress extends the Bush tax cuts. For individuals, the 3.8 percent tax will be imposed on the lesser of the individual's net investment income or the amount by which the individual's modified adjusted gross income (AGI) exceeds certain thresholds ($250,000 for married individuals filing jointly or $200,000 for unmarried individuals). For purposes of this tax, investment income includes interest, dividends, income from trades or businesses that are passive activities or that trade in financial instruments and commodities, and net gains from the disposition of property held in a trade or business that is a passive activity or that trades in financial instruments and commodities. Investment income excludes distributions from qualified retirement plans and excludes any items that are taken into account for self-employment tax purposes.

Planning Strategies. Until the Department of Treasury issues clarifying regulations, uncertainty remains regarding which types of investment income will be subject to this new tax. Taxpayers whose modified AGI exceeds the thresholds described above should consult their tax adviser to plan for the imposition of this tax. Specifically, business owners should discuss with their tax adviser whether it would be more advantageous to become "active" in their business rather than "passive" for purposes of this tax. Owners of certain business entities such as partnerships and LLCs should also consider whether a potential change to "active" status in the business could trigger self-employment tax liability. Investors in pass-through entities such as partnerships, LLCs, and S corporations should also review the tax distribution language in the relevant entity agreement to ensure that future tax distributions will account for this new tax.

Additionally, individuals will have a greater incentive to maximize their retirement plan contributions since distributions from qualified retirement plans are not included in investment income for purposes of the tax. While distributions from traditional IRAs and 401(k) plans are not included in investment income for purposes of the tax, they do increase an individual's modified AGI and may push the individual above the modified AGI threshold, thus subjecting the individual's other investment income to the tax. Individuals may also consider converting their traditional retirement plan into a Roth IRA or Roth 401(k) this year since Roth distributions are not included in investment income and do not increase the individual's modified AGI. Although the Roth conversion would be taxable at ordinary rates, individuals should consider converting this year to avoid the higher ordinary rates scheduled to take effect in 2013.

Reduction in Itemized Deductions

Under current law, itemized deductions are not subject to any overall limitation. If the Bush tax cuts expire, an overall limitation on itemized deductions for higher-income taxpayers will once again apply. Most itemized deductions, except deductions for medical and dental expenses, investment interest, and casualty and theft losses, will be reduced by the lesser of 3 percent of AGI above an inflation-adjusted threshold or 80 percent of the amount of itemized deductions otherwise allowable. The inflation-adjusted threshold is projected to be approximately $174,450 in 2013 for all taxpayers except those married filing separately.

Planning Strategies. Because the overall limitation on itemized deductions will automatically apply to higher-income taxpayers, planning strategies are limited and highly individualized. Accelerating certain itemized deductions in 2012 to avoid the limitation may trigger alternative minimum tax (AMT) liability in 2012. Taxpayers should consult with their tax adviser to discuss the impact of this limitation and whether it may be advantageous to accelerate certain deductions, if possible, to 2012.

Reduction in Election to Expense Certain Depreciable Business Assets

Taxpayers may currently elect to expense certain depreciable business assets (Section 179 assets) in the year the assets are placed into service rather than capitalize and depreciate the cost over time. Section 179 assets include machinery, equipment, other tangible personal property, and computer software. Computer software falls out of this definition in 2013. The maximum allowable expense cannot exceed a specified amount, which is reduced dollar-for-dollar by the amount of Section 179 assets placed into service exceeding an investment ceiling. Both the maximum allowable expense and the investment ceiling will decrease next year, as shown in the table below.

	2012	2013
Maximum allowable expense	$139,000	$25,000
Investment ceiling	560,000	200,000

Planning Strategies. The change in law will both significantly decrease the dollar amount of Section 179 assets that may be expensed and cause the phaseout to be triggered at a lower threshold. Accordingly, business owners should consider placing Section 179 assets into service in 2012 to take advantage of the immediate tax benefit. Additionally, purchases of qualifying computer software should accelerated to 2012 if possible, as such purchases will no longer qualify for expensing in 2013.

AMT Preference for Gain Excluded on Sale of Qualified Small Business Stock

Taxpayers may exclude from their income all or part of the gain from selling stock of certain qualified C corporations that the taxpayer held for more than five years. The percentage of gain that may be excluded depends upon when the taxpayer acquired the stock (a 100 percent exclusion applies only to qualified stock acquired between September 28, 2010 and December 31, 2011). Under current law, 7 percent of the excluded gain is a preference item for AMT purposes. In 2013, this tax preference is scheduled to increase to 42 percent of the excluded gain (or 28 percent of the excluded gain for stock acquired after 2000). Gain excluded on stock for which the 100 percent exclusion applies will not be a tax preference for AMT purposes.

Planning Strategies. The increase in the percentage of excluded gain that will be treated as a tax preference for AMT purposes effectively eliminates the tax benefit of selling qualified small business stock. Those who are structuring a new business venture should reconsider forming a C corporation to take advantage of this provision, and should consult with their tax adviser to consider other entity choices. Owners of qualifying businesses who are considering selling their stock in the near future should also give additional consideration to a 2012 sale to take advantage of the current 7 percent AMT preference rate before the AMT preference rate increases in 2013.

Built-in Gains Tax Applicable to Certain S Corporations

Businesses that have converted from a C corporation to an S corporation are potentially subject to a corporate-level 35 percent built-in gains tax (BIG tax) on the disposition of their assets to the extent that the aggregate fair market value of the corporation's assets exceeded the aggregate basis of such assets on the conversion date. In the case of fiscal years beginning in 2011, the BIG tax does not apply if the five-year anniversary of the conversion date has occurred prior the beginning of the fiscal year. However, in the case of fiscal years beginning in 2012 or thereafter, the BIG tax will not apply only if the ten-year anniversary of the conversion date has occurred prior to the beginning of the fiscal year.

Planning Strategies. Owners of S corporations that are still in their 2011 fiscal year and that are considering selling corporate assets (or stock if a Section 338(h)(10) election will be made) within the near future should consider selling in the current fiscal year, if possible, to the extent their conversion to S corporation status occurred more than five, but less than ten years prior to the beginning of the fiscal year. For example, a C corporation that converted to an S corporation at the beginning of its fiscal year commencing October 1, 2005 would not be subject to the BIG tax on any of its built-in gain if it sold assets at any time prior to September 30, 2012, but would be subject to the tax if it sold assets on or after October 1, 2012.

Other Changes Affecting Individuals

• Additional employee portion of payroll tax. The employee portion of the hospital insurance payroll tax will increase by 0.9 percent (from 1.45 percent to 2.35 percent) on wages over $250,000 for married taxpayers filing jointly and $200,000 for other taxpayers. The employer portion of this tax remains 1.45 percent for all wages. This provision, which was enacted as part of the PPACA, is scheduled to take effect in 2013 regardless of whether Congress extends the Bush tax cuts.


• Phaseout of personal exemptions. A higher-income taxpayer's personal exemptions (currently $3,800 per exemption) will be phased out when AGI exceeds an inflation-indexed threshold. The inflation-adjusted threshold is projected to be $261,650 for married taxpayers filing jointly and $174,450 for unmarried taxpayers.


• Medical and Dental Expense Deduction. As part of the PPACA, the threshold for claiming the itemized medical and dental expense deduction is scheduled to increase from 7.5 to 10 percent of AGI. The 7.5 percent threshold will continue to apply through 2016 for taxpayers (or spouses) who are 65 and older.


• Decrease in standard deduction for married taxpayers filing jointly. The standard deduction for married taxpayers filing jointly will decrease to 167% (rather than the current 200%) of the standard deduction for unmarried taxpayers (currently $5,950). In 2012 dollars, this would lower the standard deduction for joint filers from $11,900 to $9,900.


• Above-the-line student loan interest deduction. This deduction will apply only to interest paid during the first 60 months in which interest payments are required, whereas no such time limitation applies under current law. The deduction will phase out over lower modified AGI amounts, which are projected to be $75,000 for joint returns and $50,000 for all other returns.


• Income exclusion for employer-provided educational assistance. This exclusion, which allows employees to exclude from income up to $5,250 of employer-provided educational assistance, is scheduled to expire.


• Home sale exclusion. Heirs, estates, and qualified revocable trusts (trusts that were treated as owned by the decedent immediately prior to death) will no longer be able to take advantage of the $250,000 exclusion of gain from the sale of the decedent's principal residence.


• Credit for household and dependent care expenses. Maximum creditable expenses will decrease from $3,000 to $2,400 (for one qualifying individual) and from $6,000 to $4,800 (for two or more individuals). The maximum credit will decrease from 35 percent to 30 percent of creditable expenses. The AGI-based reduction in the credit will begin at $10,000 rather than $15,000.


• Child credit. The maximum credit will decrease from $1,000 to $500 per child and cannot be used to offset AMT liability.


• Earned Income Tax Credit. The phaseout ranges for claiming the credit, which vary depending on the number of qualifying children, are scheduled to decrease for joint returns. Further, the credit will be reduced by the taxpayer's AMT liability.

Other Withholding Rate Changes
The following employer withholding rate changes will take effect in 2013:

	2012	2013
Employee portion of FICA payroll taxes	4.2%	6.2%
Backup withholding rate on reportable payments	28%	31%
Minimum witholding rate under flat rate method...
...on supplemental wages up to $1 million	25%	28%
...on supplemental wages in excess of $1 million	35%	39.6%
Voluntary withholding rate on unemployment benefits	10%	15%

Foreign Account Tax Compliance Act

Regardless of whether Congress extends the Bush tax cuts, beginning in 2014, a new 30 percent withholding tax will be imposed on certain withholdable payments paid to foreign financial institutions (FFIs) and non-financial foreign entities (NFFEs) unless they collect and disclose to the IRS information regarding their direct and indirect U.S. account holders. FFIs include foreign entities that accept deposits in the ordinary course of a banking or similar business, that hold financial assets for the account of others as a substantial part of their business, or that are engaged primarily in the business of investing or trading in securities, commodities, and partnership interests. Any foreign entity that is not an FFI is an NFFE.

Withholdable payments will include U.S.-source interest, dividends, fixed or determinable annual or periodical income, and U.S.-source gross proceeds from sales of property that produce interest and dividend income. While the withholding obligation on withholdable payments to FFIs and NFFEs does not begin until 2014, FFIs will need to enter into agreements with the IRS by June 30, 2013 to avoid being subject to the withholding tax. In general, under such agreements, FFIs must agree to provide the IRS with certain information including the name, address, taxpayer identification number and account balance of direct and indirect U.S. account holders, and must agree to comply with due diligence and other reporting procedures with respect to the identification of U.S. accounts.

Depreciation and Changes in Use of Real Property

 

Depreciation

For income tax purposes, taxpayers that own rental property with gross receipts from residential or nonresidential uses should heed the rules on accounting for depreciation. This item discusses the distinction between residential and nonresidential property, depreciation, and the application of the change-in-use regulations if a rental property changes from residential use to nonresidential or vice versa.

Dwelling-Unit and Gross-Receipts Tests

Sec. 168(e)(2) defines residential rental property as any building or structure from which 80% or more of the gross rental income for the tax year is from dwelling units. Nonresidential real property is Sec. 1250 property that is not residential rental property or that does not have a class life of less than 27.5 years.

In determining whether a property meets the 80%-gross-receipts test to qualify as residential rental property, taxpayers may include in gross rental income the rental value of any portion of the building that they occupy. For hotels, motels, and other establishments, the 80%-gross-receipts test is disregarded if more than 50% of the dwelling units are used on a “transient basis.”

For purposes of defining residential rental property, “dwelling unit” means a house or apartment used to provide living accommodations in a building or structure, but it does not include a unit in a hotel, motel, or other establishment in which more than 50% of the units are used on a transient basis. Former Regs. Secs. 1.167(k)-3(c)(1) and (2), which were removed in 1993, provided that a dwelling unit was used on a transient basis if, for more than one-half of the days in which the unit was occupied on a rental basis during the taxpayer’s tax year, it was occupied by a tenant or series of tenants, each of whom occupied the unit for less than 30 days. If a dwelling unit was occupied subject to a sublease, the taxpayer looked to the sublessee to determine whether the dwelling unit was used on a transient basis.

The definition of dwelling units indicates that, under the right circumstances, properties such as nursing homes, retirement homes, and college dormitories can qualify as residential rental property as long as they do not run afoul of the transient-basis requirement. This assumes the 1993 definition of “transient basis” still applies, as the term still appears in Sec. 168(e)(2)(A)(ii)(I), which defines “dwelling unit.” In CCM 201147025, the Office of Chief Counsel cited Regs. Secs. 1.167(k)-3(c)(1) and (2) in determining that a taxpayer’s assisted-living facilities qualified as residential real property. Assuming a vacation home is subject to the transient-basis rules, the vacation home is classified as a residential rental property if the gross rental income test is met and it is rented to each tenant more than 30 days for more than 50% of the days in a tax year it is rented; otherwise, the vacation home would be classified as nonresidential real property.

Depreciation Methods, Periods, and Conventions

Sec. 167(a) permits a depreciation deduction for the exhaustion and wear and tear of property used in a trade or business or held for the production of income. Sec. 168 sets forth the methods, periods, and conventions by which a taxpayer can depreciate tangible property as permitted by Sec. 167(a).

In the case of residential rental property and nonresidential real property, Sec. 168(b)(3) states that the applicable depreciation method is the straight-line method. Sec. 168(c) states that the applicable recovery period is 27.5 years for residential rental property and 39 years for nonresidential real property. The applicable convention to be used for both residential rental property and nonresidential real property per Sec. 168(d) is the midmonth convention.

Certain property identified by Sec. 168(g) (tangible property that during the tax year is used predominantly outside the United States and certain other property) is depreciated under the alternative depreciation system (ADS). Residential rental property and nonresidential real property subject to the ADS is depreciated using the straight-line method, a recovery period of 40 years, and the midmonth convention.

Changes in Use

Because the gross rental income test is “for the taxable year,” the 80% test needs to be calculated annually. The difference in depreciation rates for residential rental property vs. nonresidential real property can be considerable.

Example: In January 2010, taxpayer X placed in service a building in New York state that met the 80%-gross-receipts test and the dwelling-unit requirement and had no transient-basis tenants. Therefore, the property met the definition of residential rental property and was depreciated using the straight-line method at an annual rate of approximately 3.6364% (12 months ÷ [12 months × 27.5 years]). (The annual depreciation rate is different in the first and last year the property is placed in service because of the application of the midmonth convention.)

In 2011, the property failed to meet the 80%-gross-receipts test and, thus, no longer qualified as residential rental property. Therefore, since the property is now nonresidential real property, it is depreciated using the straight-line method at an annual rate of approximately 2.5641% (12 months ÷ [12 months × 39 years]). (The annual depreciation rate is different in the first and last year the property is placed in service because of the application of the midmonth convention.)

Residential rental property is depreciated approximately 30% (1 – [2.5641 ÷ 3.6364]) faster than nonresidential real property. The difference can amount to a significant return on an investment via tax savings, but it also can be a big issue upon audit.

Regs. Sec. 1.168(i)-4 provides the rules for determining the depreciation allowance for MACRS property when the use changes in the hands of the same taxpayer. Use changes include when property is converted from personal property to business or income-producing use and vice versa, and when the change in the use results in a different recovery period and/or depreciation method. The allowance for depreciation under this section constitutes the depreciation deductions permitted under Sec. 167(a).

A change in the use of MACRS property occurs when the primary use of the MACRS property in the tax year differs from that of the immediately preceding tax year. The primary use of MACRS property may be determined in any reasonable manner that is consistently applied. If the primary use of MACRS property changes, the depreciation allowance for the year of change is determined as though the use had changed on the first day of the year of change.

If a change in use results in a shorter recovery period and/or a depreciation method that is more accelerated than the method used before the change in use, the taxpayer has two options: (1) The taxpayer can compute the depreciation allowance using the shorter and/or more accelerated depreciation method in the year the change in use occurred, or (2) the taxpayer may elect to continue determining the depreciation allowance as though the change in use had not occurred. These options provide a planning opportunity to suit a taxpayer’s need for more or less accelerated depreciation deductions. For example, a taxpayer with excess net operating loss carryovers might not be able to use the maximum depreciation deductions permitted and may want to use the longer, less accelerated depreciation method.

If a change in use results in a longer recovery period and/or less accelerated depreciation method than before the change in use, the taxpayer must compute the depreciation allowance using the longer and/or less accelerated depreciation method in the year the change in use occurred.

A change in computing the depreciation allowance in the year of change for property subject to Regs. Sec. 1.168(i)-4 is not a change in method of accounting under Sec. 446(e). To make the election or to disregard the election, a taxpayer needs only to complete Form 4562, Depreciation and Amortization (Including Information on Listed Property), in the year of change. However, the regulations under Secs. 446(e) and 481 apply if the taxpayer does not account for the depreciation allowance in the manner set forth by Regs. Sec. 1.168(i)-4 or revokes the election to disregard the change in use. If Secs. 446(e) and 481 do apply, the taxpayer should file a Form 3115, Application for Change in Account Method, to request an automatic change.

Property affected by the change-in-use regulations is not eligible for special depreciation deductions in the year of change, as otherwise permitted in Sec. 168(k) (bonus depreciation), Sec. 179 (election to expense certain depreciable business assets (generally not applicable to residential and nonresidential property)), and Sec. 1400L (tax benefits for New York Liberty Zone property). Additionally, for purposes of determining whether the midquarter convention applies to other MACRS property placed in service during the year, the change-in-use property is not taken into account.

Regs. Sec. 1.168(i)-4 also discusses the applicability of and options to use depreciation tables in the calculation, the rules to compute the new depreciation allowance, and assets subject to ADS.

Cost Segregation

Under the former investment tax credit (ITC) rules in Regs. Sec. 1.48-1(c), as interpreted by the Tax Court in Hospital Corp. of America, 109 T.C. 21 (1997), items in a building that qualify as tangible personal property may be separately depreciated under MACRS as personal property. Furthermore, the court held that if a building component is not personal property under the former ITC rules, it is considered a structural component and may not be depreciated separately. Therefore, a cost-segregation study identifying the structural components of specific units in a building to maximize depreciation would not be helpful to the owner(s) of a building that has tenants that use separate and identifiable units for business purposes and other units as their non–transient-basis dwelling units.

Under the temporary regulations in T.D. 9564 that apply to tax years beginning on or after Jan. 1, 2012, a taxpayer may retire a structural component of a building and use any reasonable method to allocate a cost to the component disposed of with respect to the larger asset, i.e., the building.

Conclusion

Many tax practitioners’ clients own one or more rental properties to which the above rules apply. Tax practitioners need to communicate continually with those clients that own rental properties with both residential and nonresidential receipts and test whether the property has changed use and the effect of the change on the clients’ tax returns.

2013 Tax Planning: 5 Reasons to Start Now

1. The 2013 Tax Season Is Closer than You Think

 

Industry experts generally agree that proper tax planning takes an average of six months – the time it often takes experts to educate themselves on all available opportunities, determine the best approach, and implement the plan. When you consider that six months from today puts us in March 2013, suddenly next year’s tax season doesn't seem so far away. If you really want to get the best tax outcomes in 2013: the time to start planning is now.

2. Uncertainty Looms Over Next Year’s Tax Climate

 

Next year’s tax climate can be best characterized by its extreme uncertainty, which will be brought on by changes resulting from the Supreme Court upholding the Affordable Care Act, as well as by a number of provisions in the Bush tax cuts that are set to expire. This level of uncertainty will make early 2013 a chaotic time for tax planning, and it makes now an even more important time to get the planning process started.

3. You Could Still Benefit from Generous Tax Breaks that May Be Gone Next Year

 

With many provisions of the Bush tax cuts set to expire at year end, starting your 2013 tax planning now means you’ll still have a chance to take advantage of some breaks that may be history by year end. Rates are set to increase on federal income taxes (from 36 percent to 39.6 percent), long-term capital gains (from a maximum tax rate of 15 percent to 20 percent), and dividends (to be taxed as ordinary income). Waiting too long to plan for 2013 may cause you to miss out on some of these tax breaks for good.

4. The Estate Tax Is Set to Increase

 

Significant changes are also set to take place when it comes to the estate tax. This tax is set to increase from 35 percent this year to 45 percent next, and the lifetime exemption amount will go down from $5.12 million to $1 million – unless Congressional action is taken. These changes are likely to impact your plans for 2013, and they make it even more critical that you start the planning process immediately.

5. The Alternative Minimum Tax Will Greatly Expand its Reach

 

Another large tax provision certain to have an impact on many individuals is the higher Alternative Tax Exemption, or AMT patch. This exemption is set to drop from $74,450 this tax year to $45,000 next year. This means that not only will many more people have to pay the AMT patch, but the increase in taxable income will result in even more taxes that individuals pay next year. AMT may not have applied to you in the past, but this year, it may be one of many reasons for you to plan carefully for 2013.

“Regardless of what happens in Congress between now and the end of the year, people can still ensure economic stability for themselves and their future,” said Andrew Lattimer, a partner at BlumShapiro. “But the key is starting now by consulting your tax professionals while there is time to plan without being caught up in what is certain to be a chaotic early 2013."

 

Quarterly Tax Payments Information

For all the freelancers, small business owners and self-employed individuals out there, staying on top of when the estimated tax payments are due is important to help you stay within the IRS tax payment guideline and avoid penalty. Making estimated tax payments also helps you avoid financial shortfall when you file your tax returns. Here’s the full schedule for 2012 and 2013 tax year.

Quarter	Period	2012 Due Dates	2013 Due Dates
Q1	January 1 – March 31	April 17, 2012	April 15, 2013
Q2	April 1 – May 31	June 15, 2012	June 17, 2013
Q3	June 1 – August 31	September 17, 2012	September 16, 2013
Q4	September 1 – December 31	January 15, 2013	January 15, 2014

Remember you have to pay both the IRS and your State. Hopefully, you have been saving up for this and have money in a savings account to cover the tax payments.

Frequently Asked Questions

Shouldn’t the June date actually be July?

June the correct date. Q2 payment is due faster than the rest and you only have to pay taxes against 2 months’ worth of earnings (April and May). Subsequently, this means Q3 payment occurs in September and Q4 payment encompasses 4 months of income instead of three.

 

How can I lower my tax payments?

You can lower your tax liabilities by participating in a retirement plan designed for self-employed individuals and business owners.

Will the IRS send me the quarterly estimated tax forms in order for me to send in my estimated tax?

No, you have to calculate the amount for both the Federal and States taxes. For Federal, you have to complete Form 1040-ES and send it along with your payment. For State, you have to search online for the appropriate form, complete it and send it in with your payment.

Alternatively, you can submit your Federal payment electronically via EFTPS; and most States should have the online equivalent.

Where should I send the estimated tax payments?

For Federal payment, the answer depends on where you live. Check the instruction included in Form 1040-ES for the correct mailing address. Similarly, check with your State tax department for the correct mailing address for your State payment.

Do quarterly tax payments have to be received by the due date or just post marked by then?

The deadline is the postmarked date.

Can the quarterly payment amount change each quarter?

Yes, the amounts can be different for each quarter depending on your earnings.

Should you be worried about 2013?

Here's a look at the laws that could wage a multipronged attack on your wallet and what you can do to prepare.

Over the last few years, Americans have observed a series of tense Capitol Hill confrontations over what to do about expiring tax code provisions. While each was significant, their scale is dwarfed by what looms at the end of this year: Without action by Congress, Americans face a half-trillion-dollar tax hike in 2013, according to the Tax Foundation — a scenario so ominous that pundits have nicknamed it "taxmageddon."

While the outcome is anyone's guess, it's important to know what hangs in the balance and what it could mean for your bottom line.

What's at Stake	What Will Happen Jan. 1 Without Federal Action
Income Tax Brackets	Rates would rise for all Americans, with the lowest bracket rising from 10% to 15% and the highest from 35% to 39.6%.
Dividends	Would be taxed at the same rate as ordinary income — instead of today's 15% maximum rate.
Capital Gains	Maximum rate would rise to 20% from the current 15%.
Personal Exemptions and Itemized Deductions	Would be reduced for high-income taxpayers.
Alternative Minimum Tax	Without extension of temporary exemptions, more taxpayers will be snared by this parallel tax system.
Payroll Taxes	Individuals' share of Social Security taxes would return from the temporary 4.2% to the normal 6.2%; the self-employment tax rate would rise from 10.4% to 12.4%.
Estate Taxes	Maximum estate tax rate would rise to 55% from the current 35%; estates valued at more than $1 million would face the tax (versus the current $5 million).
Education Savings	The annual contribution limit for Coverdell Education Savings Accounts would fall from $2,000 to $500 and qualified withdrawals would no longer be permitted for K-12 expenses.
Child Tax Credit	Falls from $1,000 to $500.
Married Couples Filing Joint Returns	The expiration of features meant to address a so-called "marriage penalty" would reduce standard deductions and push many couples into higher tax brackets.
Adoption Credits Joint Returns	Maximum credit would fall from $13,360 to $6,000 and would only be available for special needs children.
Other Popular Tax Breaks Joint Returns	Deductions for state and local sales taxes, higher education and teachers' classroom supplies all would vanish.

An Uncertain Outcome

Adding to the pressure, members of Congress will grapple with these broad-reaching tax expirations while facing national elections and a related showdown over what they should do when the nation again reaches its debt ceiling. That is the amount of debt the federal government is authorized to have.

 

 

Don't expect a clear outcome anytime soon. "Frankly, it's unlikely that it will be resolved before the November 6 election," says Dan Brouillette, USAA senior vice president for government and industry relations.

A bipartisan group of senators has begun working in hope of having a package ready shortly after the election, Brouillette says. "However, their final product could depend on the election results."

As with many recent tax issues, the nation may get a short-term extension that preserves our current tax rules for a few months or a year or two. On the other hand, the resolution could come in the form of sweeping tax reform that stretches to other tax provisions that aren't set to expire.

Personal Tax Moves: Watch and Wait

Given all the uncertainty, what should USAA members do? J.J. Montanaro, a CERTIFIED FINANCIAL PLANNER™ professional at USAA, offers three pointers:

• Don't make big bets. "Since the outcome is unpredictable, I wouldn't make any big financial decisions based on an assumption that the tax debate will end one way or another," Montanaro says.


• Tighten your budget. "If your taxes do increase, you'll be better prepared. If they don't, you'll have a windfall to dedicate to other goals," he says.


• Stay alert. "Once the outcome is known, you may find it will be to your advantage to make some financial moves this year — under the current tax law," Montanaro says. For example, if you face higher capital-gains rates in 2013, it may be better to sell some of your investments sooner rather than later.

If recent experience is any guide, Congress may not act until late December. That means you may have limited time for those late-year decisions. Until then, keep monitoring for timely updates.

Tax Myths

In written form, the tax code could make an encyclopedia set blush. With so many codes occupying so much shelf space, no wonder we are confused at times trying to determine what is a fact and what is a myth.

With that in mind, here are some commonly held tax beliefs that have no authenticity. Watch out for these; even the IRS does not want you to pay more taxes than what you legally owe.

Myth - I can stop filing once I reach a certain age

While it may be true that a person retiring on Social Security as their sole income likely will not have a filing requirement, there is no age at which one can legally stop filing. Return filing is based on income, not age. Even a person on Social Security may have to file and pay tax if they have other income sources, like a taxable pension, IRA distributions, or investment income. If so, a portion of your Social Security may be taxable as well.

Myth - I'm a student; I don't have to pay taxes

Students are not exempt from filing and taxation, assuming they have earned income. Many students will take up summer jobs and claim "exempt" (from tax withholding) on their W4. This is fine, assuming the amount earned will be under the threshold for taxation.

For example, a single individual under age 65 was required to file a 2011 tax return if their earned income was over $9,500. Even if the amount earned was under that, a return should be filed to claim any tax withheld as a refund.

Myth - My child is over 19; I can't claim him as a dependent

As long as your son or daughter is a full-time student as defined by the IRS, you can still claim them. Your child must be under age 24 and enrolled, in some part, during at least five calendar months, in the number of courses and or hours that the college considers "full-time." If so, they can be claimed as your dependent as long as they meet the other requirements.

Myth - I can't deduct state sales tax

Yes it's a myth. The IRS allows you deduct actual sales tax you paid on food, clothing, medicine and most other purchases. Even the tax on a large purchase, like a vehicle, can be deducted as long as the rate is the same. The one stipulation? You must be able to itemize your deductions to make it worthwhile.

In lieu of sales tax, you can deduct state income tax. Use the amount that will yield a higher deduction. If deducting sales tax in combination with your other Schedule A itemized deductions is higher than your standard deduction, then this is the way to go.

Myth - Now that I'm married, I have to file with my spouse

The IRS doesn't want to get involved in your marriage, so they have left this one up to you. You can choose to file together, or you can opt to use the filing status Married Filing Separate.

The advantage to filing separate? Perhaps you want to make a clear distinction and be responsible only for your tax. This may be true if your spouse has previous tax debts or owes other federal or state agencies. The IRS does have programs however (Injured Spouse and Innocent Spouse) to shield the non-liable party.

At times, a separate filing may also result in less tax owed as a whole. For example, if you plan on itemizing your deductions because you both have deductions to claim on your Schedule A, then those collective deductions are subject to percentage limitations. But if you were to file separately, you likely would be able to get more of those deductions accounted for and overall pay less combined tax.

Another filing status that may be available even if you are married? Head of Household. If your spouse did not live with you during the last six months of the calendar year, and if you kept up a home for yourself and at least one other person for whom you can take an exemption for, then you can file Head of Household and receive a greater Standard Deduction.

2013 Tax Changes

2012 not only marks the end of the Mayan calendar, but also the tax cuts of 2001 and 2003 under George W. Bush. With the aspect of likely higher taxes looming in 2013 some Congressional aides have termed the upcoming expiration of the Bush tax cuts as “Taxmageddon”. Are the expiration of the tax cuts in 2013 really going to be that painful for most people? If your income is below $200,000 to $250,000 probably not.  Let’s take a look at some of the expiring provisions and the tax proposals that President Obama has included with his 2013 budget.

For the last couple of years ever since the “Bush” tax cuts of 2001 were extended through 2012, there has been much consternation as to what is going to happen to tax rates in 2013 when the extensions expire.  A couple of weeks ago we got a peek at what President Obama’s proposed changes to taxes will be if he gets his way when he unveiled his 2013 budget. Of course, the budget and tax provisions will have to be approved by Congress, and there is a good chance that debate on tax law changes will drag out through much of 2012. It is very likely the proposals discussed below will be changed. We will likely not know for sure exactly what tax rates are going to be in 2013 and beyond until the end of 2012. However, we can look at the provisions that the President has included in his fiscal year 2013 budget and get an idea of the starting point of where tax rates may be in 2013 and beyond and if you need to worry much. Below is a look at some of the provisions that may affect the largest number of people:

Allow Top Two Income Tax Rates to Rise After 2012

The president is not really proposing an increase for the top income tax bracket in 2013, but simply allowing the current law to expire and reverting to the pre-2001 levels.  This means that all taxpayers in the current 35% bracket would increase to 39.6%, this means you, if your taxable income is greater than $390,050, regardless if you are single, married or head of household.

The changes come in the 2^nd highest brackets which are currently paying 33%, getting increased to 36%. But, this is only going to apply to joint taxpayers with Adjusted Gross Income (AGI) over $250,000 ($200,000 for single filers). The values are in 2009 dollars and would be indexed for inflation in future years. These taxpayers will be referred to as “upper income taxpayers”. The projected tax table is shown below along with current rates. For joint filers, with taxable income below the $250,000 threshold, but above the 28% tax bracket, their rates would stay at 33%, which would actually be a tax cut under the pre-2001 tax rates that the tax laws are reverting to.

For those taxpayers currently in the10%, 15%, 25% and 28% tax brackets there are not any proposed changes. Those people currently in the 33% bracket would only be affected if they are considered an upper income taxpayer.



 

Chart courtesy of taxpolicycenter.org

Tax Long Term Capital Gains at 20%

Ever since 2003 long term capital gains tax for assets held longer than 1 year has been 15% for those in the 15% bracket and higher, and 10% for those in the 10% bracket. (Since 2008 taxpayers in the 10% and 15% bracket actually paid no tax on long term capital gains).  Under current tax laws, rates are set to revert in 2013 to their pre-2003 levels. This means for all taxpayers in the 15% bracket and below, long term gains would be taxed at 10%. For single taxpayers with taxable income below  $200,000, head of households below $225,000 and joint couples below $250,000 your long term rate would remain at 15%. Only filers above these amounts would have a have a 20% long term capital gain rate.

Tax on Dividends

Another highly watched area of the proposed budget has been what the tax rate will be on qualified dividends. Before 2003, dividends were taxed at your ordinary income tax rate. Since 2003, though, the maximum qualified dividend tax rate has been 15%. (Since 2008, taxpayers in the 15% bracket or below pay no tax on qualified dividends.)  When the current law expires in 2013, dividends would revert back to being taxed at your ordinary income tax rate.

President Obama’s budget proposal would keep the current dividend rate of 15% for everyone not considered an upper income taxpayer (single taxpayers with taxable income below $200,000, head of households below $225,000 and joint couples below $250,000). For the upper income taxpayers above these amounts, dividends would be taxed at your ordinary income tax rate of either 36% or 39.6%.

Limit Value of Itemized Deductions to the 28% Bracket

Itemized deductions allow one to reduce taxable income be deducting amounts greater than the standard deduction. This includes things such as charitable deductions, mortgage interest, state income taxes, medical expenses, etc.  Itemized deductions are generally more valuable to upper income taxpayers  because the effect on tax liability is greater when you are in a higher tax bracket.  For example, itemized deductions of $10,000 reduce taxes for someone in the 15% bracket by 15% (15% of $10,000). But for someone in the 35% bracket, the $10,000 of deductions results in $3,500 of tax savings (35% of $10,000).

With the president’s 2013 budget proposal, the value of itemized deductions for those upper income taxpayers ($200,000 & $250,000), would be capped at 28%, so someone in the 35% that currently receives $3,500 of benefit for those $10,000 of itemized deductions, would only receive $2,800 of tax savings because of the 28% cap.

The possible effects of this likely have many charitable organizations concerned, as higher income donors are many charities biggest sources of revenues and if these people are not going to get as much “bang for their buck” with their charitable gifts, they may possibly give less in the future. You could also argue that investment in housing could be affected as well, since mortgage interest wouldn’t get the full benefit of the upper income taxpayer.

One other thing to consider, the limitation on itemized deductions (known as Pease after the congressman that helped create it) is scheduled to return in 2013. This limit reduces most itemized deductions by 3% of the amount by which AGI exceeds a specified threshold, up to a maximum deduction of 80% of itemized deductions. It was eliminated for 2010, 2011 & 2012, but unless the tax laws are changed will be back in 2013. It is likely it will affect only the upper income taxpayers ($200,000/$250,000) as well, but this combined with the 28% maximum itemized deduction limit could really reduce deductions for higher income taxpayers substantially.

Alternative Minimum Tax (AMT)

The Alternative Minimum Tax (AMT) was enacted in 1969 to impose tax on a small group of ultra- wealthy individuals that were paying little or no income tax because of excessive write-offs and deductions. AMT is a separate tax imposed on nearly a flat rate on an amount of income over a certain threshold (exemption). In computing taxable income, your regular federal tax is compared to the amount calculated under AMT and you are responsible for the greater of the two amounts. No deductions are allowed for things such as state income taxes or miscellaneous itemized deductions. The reason AMT has become such an issue the last few years and affecting more and more people at lower incomes, is because the exemption amount has never been indexed for inflation, so it is at a very low rate. The last several years, Congress has enacted a late December patch to inflation adjust the exemption. Due to the infinite wisdom of our elected officials, they have never added an automatic inflation increase to the AMT exemption, and we don’t know until late in the year if we will be paying several thousand dollars more in tax or not.

President Obama’s proposed budget has provisions that use the 2011 exemption amounts and permanently index the amount for inflation going forward, which would eliminate the last minute fixes by Congress.

Estate and Gift Taxes

In 2001, Congress voted to phase out the estate tax gradually and repeal it entirely in 2010. The 2010 tax act reinstated the tax with an effective $5 million exemption and a 35 percent tax rate. The act also for the first time allowed portability of the exemption between spouses: any of the $5 million exemption not used when one spouse dies may be added to the exemption available for the second spouse (if he or she has not remarried). However, unless Congress acts, the estate provisions in effect prior to 2001 would be reinstated starting in 2013, Under these provisions, estates valued at $1 million or more would again be subject to tax at progressive rates as high as 60 percent, and portability would disappear.

The Obama budget proposes permanently setting the estate tax at its 2009 level beginning in 2013: estates worth more than $3.5 million would pay 45 percent of taxable value over that threshold. It would also make portability permanent, allowing couples to share a combined exemption of $7 million. Relative to current law, the proposal would cost $271 billion in forgone revenues through 2021. (-From Tax policy Center website)

There are several more provisions for individuals and businesses in the proposed budget, but we wanted to focus on the areas that will likely have the impact on the largest amount of our clients and friends. Again, these are just the first proposals, there will be a lot of negotiations between the Republicans and Democrats before the final tax provisions are settled upon. From the looks of things right now, if your taxable income isn’t greater than $200,000 for individuals or $250,000 for joint filers, you probably would not see a lot of changes in your tax bill if the proposed changes make it to law.

Finally, Doug Short of Advisor Perspectives (always has great charts) has a neat chart showing the Federal Debt, including the effects of President Obama’s 2013 budget on top with the historical income tax brackets shown on the bottom half. When you step back and look at the long term, even with the proposed increases in income taxes for the upper income taxpayers, overall tax rates are a lot lower than they were in the middle of the 20^th century. Of course, there were a lot more available tax deductions back then, so it may not really be all that different after all. But, I am just trying to cheer you up.