October 2010
Dear Clients and Friends:
Congress has put off making any changes to either the income tax or estate tax rates, instead choosing to use their ideas as talking points for the upcoming election. However, one new tax act has passed since our last newsletter. Additionally, it is expected that Congress will address the expired income tax and estate tax issues either at year end or early next year. Here’s what we know so far:
The Small Business Jobs Act of 2010
Congress recently passed The Small Business Jobs Act of 2010. The Act consists largely of temporary small business tax provisions, many of which are effective for 2010 only. Some highlights of the Act are:
· Rollovers are allowed from 401k, 403B and governmental 457B plans to designated Roth IRAs. Of course, the roll over amount is taxable.
· Business owner’s health insurance premiums are deductible when calculating self- employment tax (for 2010 only).
· Bonus depreciation has been extended through 2010, which allows for a 50% deduction in the first year for qualifying new property.
· The Section 179 deduction has been increased and expanded for tax years 2010 and 2011. Taxpayer’s may expense up to $500,000 of the cost of qualified tangible personal property. The $500,000 limit includes up to $250,000 of the cost of tangible real property expenditures. Qualifying real property is: 1) interior leasehold improvements in a non-residential building made pursuant to the lease, 2) restaurant improvements provided that at least 50% of the building is a restaurant, and 3) retail improvement property provided the building has been in service for at least 3 years.
· The deduction for startup expenses has increased from $5,000 to $10,000 for 2010.
Business owners purchasing new heavy SUVs should welcome the return of the 50% depreciation. If your business buys a new $50,000 SUV with a loaded weight of over 6,000 pounds and puts it into service by December 31, 2010, you can expense $25,000 in 2010, the maximum for vehicles. Additionally, you can claim $12,500, half of the remaining $25,000 cost, as bonus depreciation. The total first-year write-off is $37,500 assuming the auto is used 100% for business. Note that bonus depreciation is only allowed on new property. Also note that this example assumes 100% business use of the vehicle.
IRS audit news
Based on our recent audit experience representing individual tax clients, the IRS appears to be taking a more common sense approach to audits. The IRS is reviewing taxpayer’s overall tax picture to see if the income appears reasonable given the taxpayer’s overall living costs. If you were audited:
· If the IRS were to add up all of the deposits in your bank account, would you be able to reconcile that amount with the total income reported on your tax return?
· If the IRS were to review your tax return, does it appear that you can afford the basic living costs in your area? If you’re reporting $40,000 of income but spending $60,000 on housing, food, and other personal expenses, do your credit card statements, lines of credit and other sources of cash explain how you are paying for the $20,000 shortfall?
· Do you have cancelled checks and / or receipts to justify all deductions taken?
· Have you purchased our audit representation agreement to help cover the costs of a potential audit?
There may only be 2 more months of the lower tax rates – time to start some yearend planning
A slew of tax provisions and tax cuts are set to expire in 2010. A substantial number of Democrats and Republicans in Congress are in agreement that the tax rates should remain low for the lower and middle income taxpayers as the economy continues to lag. Democrats, however, would like to see higher tax rates for the high income taxpayers. For many this will mean higher federal taxes next year. The expected changes are:
· The 10% tax bracket is eliminated
· The 35% top tax bracket increases to 39.6%
· The 33% bracket will be 36%
· The maximum tax rate for qualifying dividends and capital gains is set to jump from 15% to 20%
· The higher Alternative Minimum Tax (AMT) exemptions are set to expire
· The deductions for sales tax and college tuition are set to expire
It is likely that the reduced tax rates will remain in effect for those in the lower tax brackets but will possibly increase for those in the higher brackets.
The next few months is a good time to do some tax planning if you are considering selling assets, withdrawing a large amount from your retirement plan, exercising stock options, or buying new business assets. This is especially true if you are in the higher tax brackets as your tax rates may go up next year.
Some yearend tax strategies to consider
· Property taxes and state income taxes are deductible by those who itemize unless you are subject to the alternative minimum tax. Should you pay your property taxes and state income taxes early or wait until 2011 to pay these?
· If you file a Schedule C and use the cash method of accounting – you can delay year-end billings and pay outstanding business expenses before year end. Does it make sense in your case to lower your business income this year?
· Have you sold any stocks at a loss or do you have a capital loss carryover? If yes, consider selling some winners to offset your capital losses.
· Help your parents' estate plan - ask them for a gift of $13,000.
· Be charitable (clean out the closets and garage).
· Maximize your 401k contributions.
· Do you have a net operating loss or do your expenses exceed your taxable income for the year? If yes, consider converting some of your traditional IRA to a Roth IRA before year end.
· Consider buying new business assets before December 31, 2010 so you can take advantage of the bonus depreciation.
Social Security planning
Currently you can repay your social security benefits and then reapply. This strategy may make sense if you began taking benefits before full retirement age or took the benefits at full retirement age but should have waited for age 70 to get a higher payout. The repayment amount is the benefits paid to you (or to someone else on your account) plus any deduction for Medicare Part B and tax withholding; however, no interest is due on the repayment. Kiplinger has written extensively about this strategy, so the Social Security Administration is moving to eliminate or restrict its use. If this may apply to you, you should act quickly before the rules change.
Did your kids / grandkids work this summer?
If your kids / grandkids worked this summer, consider contributing to a Roth IRA on their behalf. The annual contribution limit is $5,000, but not more than the child’s earnings. A $5,000 contribution to a 16 year olds Roth that earns 8% each year will grow to $217,000 at age 65.
New tax law changes for taxpayers in the higher tax brackets
Congress passed a health-care bill in March that contains two new taxes taking effect in 2013 to help pay for the changes; an extra 0.9% levy on wages for couples earning more than $250,000 ($200,000 for singles) and a new 3.8% tax on investment income on those same people (technically, people with "adjusted gross incomes" above those amounts).
While many details remain unclear and the Internal Revenue Service hasn't issued any guidance, here are preliminary answers to some questions.
The 0.9% tax
If husband and wife each earn $175,000, their total employment income is $350,000. Currently, they owe 1.45% ($5,075) of regular Medicare tax and their employers owe a matching amount. In 2013, the couple will owe an extra 0.9% ($900) on their combined wages above $250,000. Their employers pay nothing extra.
The 3.8% Medicare tax on net investment income
Single filers with modified adjusted gross income over $200,000 and married filers over $250,000 are subject to this surtax. (This is simply adjusted gross income for nearly everybody except expatriates, who must add back certain exclusions.) The tax is a flat 3.8% on investment income above the threshold.
Planning issues for the 3.8% tax – what you can do now
Examine both your regular and investment income: the higher your regular income, the more likely that your investment income will be subject to the new tax. This makes Roth IRA conversions more attractive for many. Roth withdrawals don't raise adjusted gross income and aren't investment income.
Consider a defined-benefit pension if you're in a small business or have consulting income. Pension payouts don't count as investment income, and the older a taxpayer is, the more he can contribute.
Taxpayers selling assets should consider installment sales after 2012 and electing out of installment sale treatment, if the sale is before 2013.
What will happen to the estate tax?
Of course, we do not yet know. For 2010 there is no estate tax and there is a limited step up in basis. The estate tax is scheduled to be effective once again beginning January 1, 2011 with a $1,000,000 exemption and a 55% top rate. Because there will be an estate tax, assets which are inherited get a step up in basis to the fair market value at the time of death. We see three possibilities:
1. No action, so that the above rules apply.
2. Retroactive extension of the 2009 rules to 2010 and 2011.
3. Elective retroactive extension of the 2009 rules (pay estate tax and get the step up or don’t pay and get a limited step up).
Please call us if you have any questions about the issues in this newsletter or about any other tax, accounting or financial planning issues.
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