• What does the term "The Fiscal Cliff" mean?

    15 November 2012 / Uncategorized / Comments Off on What does the term "The Fiscal Cliff" mean?

    What does the term "The Fiscal Cliff" mean?

    You can’t pick up a newspaper or go online without seeing stories about the coming “fiscal cliff”, “tax cliff” or “taxmageddon”.  What exactly do these terms mean?  What is coming and how will affect you?  This article will discuss the situation that is behind all of these terms, and should shed some light on what you can expect for your own personal tax situation.

    All of these terms refer to the time at the end of this year when the current tax rates for income, capital gains, gifts, and estates are scheduled to expire. Mostly overlooked by the news media are a large number of other tax provisions that are also scheduled to expire or have already expired.  Now, year-end tax law changes are nothing new; the implications for this year, however, are significant.  The so-called cliff represents the potential onset of federal tax increases and spending cuts (all slated to take effect January 1, 2013) that could have a substantial impact on the economy.  One analysis indicates that 90% of Americans will see a tax increase in 2013 under current law!

    The country faced a similar situation at the end of 2010, when, after having over seven years to prepare for the sunset of the lower income, estate, and gift tax rates enacted in the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) and the sunset of the lower capital gains tax rates enacted by the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), Congress had to scramble to prevent the tax rates from rising.  The House and the Senate finally enacting a short-term solution in mid-December 2010 in the form of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Tax Relief Act), which extended the ordinary income tax rates and the capital gains tax rates, reinstated the estate tax at a reduced rate, and extended a large number of expired or expiring provisions.

    This year the country faces the same prospect. Many of the 2010 Tax Relief Act extensions expired at the end of 2011, and the rest expire at the end of this year. This article details the tax provisions that affect most of Widget’s clients that have expired and will expire if Congress does not act.  It, however, is NOT an all-inclusive list.

    In August, the Senate Finance Committee approved a bill, the Family and Business Tax Cut Certainty Act of 2012 that would extend some, but not all, of the expired provisions through 2013. This may signal that, when Congress does act, it will not extend every expired provision because of the cost in lost federal revenue.  Tax provisions for individuals that the bill focused on included restoring the alternative minimum tax (AMT) patch and the deduction for state and local sales tax. Provisions for businesses included extending the research and development credit, the work opportunity credit, and the increased Sec. 179 expensing amounts. In all, the bill would extend or restore 11 provisions for individuals, 28 for businesses, and 13 energy incentives. It did not address the impending changes to income, estate, and capital gains tax rates.

    The Joint Committee on Taxation estimated that renewing even this smaller list of provisions would cost more than $192 billion in lost revenue from fiscal year 2013 through fiscal year 2017. The fate of this bill is hard to predict.

     

    Key Provisions Set To Expire At the End of 2012:

    Tax rates

    EGTRRA introduced a new 10% tax bracket below the 15% bracket for individuals and reduced the other tax brackets to 25%, 28%, 33%, and 35%. Those changes are scheduled to sunset after 2012 so that in 2013 the 10% rate will disappear (with income in that bracket reverting to the 15% bracket) and the other rates will revert to 28%, 31%, 36%, and 39.6%, respectively.

    In 2003, JGTRRA also lowered the capital gains tax rate to 15% (0% for taxpayers in the 10% and 15% income tax brackets). These rate changes are also scheduled to expire after 2012. The rates will revert to 10% for taxpayers in the 15% income tax bracket and 20% for other brackets (8% or 18% for property held more than five years (but to qualify for the 18% rate, the holding period must begin after Dec. 31, 2000)). The taxation of qualified dividend income at capital gains rates will also expire at the end of 2012 and they will taxed as ordinary income.

    EGTRRA’s repeal of the itemized deduction phase-out (Sec. 68(g)) and the personal exemption phase-out (Sec. 151(d)(3)) is also scheduled to expire after 2012.

    Payroll tax reduction

    The lower 4.2% rate for employees’ portion of the Social Security payroll tax will expire at the end of 2012 and revert to 6.2%.

    AMT provisions

    The 0% and 15% capital gains rates for the AMT, the AMT offset of the child tax credit, and the 7% AMT preference for excluded gain on the disposition of qualified small business stock are scheduled to expire at the end of 2012.

    Bonus depreciation and Sec. 179 expensing

    The 2010 Tax Relief Act sets the expensing limitation under Sec. 179 at $125,000 and the phase-out threshold amount at $500,000 for 2012. For tax years beginning after 2012, these amounts reduce to $25,000 and $200,000, respectively.

    The availability of an additional 50% first-year bonus depreciation (Sec. 168(k)) expires at the end of 2012. The election to accelerate AMT credits in lieu of bonus depreciation (Sec. 168(k)(4)) also expires at the end of 2012.

    Increased AMT exemption (Sec. 55(d))

    Congress has temporarily increased the AMT exemption amount several times in recent years. These successive increases are commonly referred to as the “AMT patch.” The 2010 Tax Relief Act increased the AMT exemption amounts, but only for 2010 and 2011. With the AMT patch amounts now expired, the AMT exemption has reverted to its statutory amount: $45,000 for married individuals filing jointly, less 25% of alternative minimum taxable income (AMTI) exceeding $150,000; and $33,750 for unmarried individuals, less 25% of AMTI exceeding $112,500.

    Estate, gift, and GST tax

    The 2010 Tax Relief Act reinstated the estate, gift, and generation-skipping transfer (GST) tax at a rate of 35% and an estate, gift, and GST tax exemption of $5 million ($5.12 million in 2012, adjusted for inflation). In addition to the increase in the exemption amount, for decedents dying after 2010, the estate tax exemption of the first spouse to die is “portable.” That is, if an election is made, the surviving spouse’s exemption amount is increased by the deceased spouse’s unused exemption amount.

    After 2012, if Congress does not act, the estate, gift, and GST tax regime that existed in 2000 will return. The exemption amount will be $1 million, and the top rate will be 55%! Ouch!

    OTHER EXPIRING PROVISIONS

    A variety of other temporary tax provisions are scheduled to expire at the end of 2012. These include tax credits, deductions, and various tax incentives.

    Key Individual provisions:

    • Marriage penalty relief (i.e., the increased size of the 15% rate bracket (Sec. 1(f)(8)) and increased standard deduction for married taxpayers filing jointly (Sec. 63(c)(2)));
    • The liberalized child and dependent care credit rules (allowing the credit to be calculated based on up to $3,000 of expenses for one dependent or up to $6,000 for more than one) (Sec. 21);
    • The $1,000 child tax credit amount (scheduled to revert to $500) and the expanded refundability of the credit (Sec. 24);
    • The American opportunity tax credit (Sec. 25A);
    • The increased starting and ending points for the earned income tax credit and the increase in the credit amount for families with three or more qualifying children (Sec. 32);
    • Refundability of the credit for prior-year minimum tax liability (Sec. 53(e));
    • Exclusion from gross income for discharge of indebtedness on a principal residence (Sec. 108(a)(1)(E));
    • The exclusion for employer-provided educational assistance (Sec. 127);
    • The enhanced rules for student loan deductions introduced by EGTRRA (Sec. 221);
    • The higher contribution amount and other EGTRRA changes to Coverdell Education Savings Accounts (Sec. 530).

    In addition to the large number of provisions scheduled to expire, many provisions expired at the end of 2011 and have not been reenacted.

    • The expanded adoption credit (Sec. 23) and adoption-assistance program (Sec. 137) amounts;
    • The nonbusiness energy property credit (Sec. 25C);
    • The deduction of up to $250 for certain elementary and secondary school teacher expenses (Sec. 62(a)(2)(D));
    • Deductibility of mortgage insurance premiums as interest (Sec. 163(h));
    • Deductibility of state and local sales tax instead of state income taxes on Schedule A (Sec. 164(b));
    • The above-the-line deduction of up to $4,000 for qualified tuition and related expenses (Sec. 222);
    • The tax-free treatment of charitable distributions from IRAs (Sec. 408(d)(8));
    • The District of Columbia first-time homebuyer credit (Sec. 1400C); and
    • The temporary 100% exclusion of gain from the sale of certain small business stock (Sec. 1202(a)).

    There are many other expiring provisions for individuals that are not covered in this article due their obscure nature.

    Key Business Provisions:

    Many business tax incentives expired at the end of 2011. Perhaps the most significant of these are the expiration of the allowance for 100% first-year bonus depreciation (it is reduced to 50% for 2012) (Sec. 168(k)) and the expiration of the increased deduction amounts under Sec. 179. The Sec. 179 expensing limitation was reduced to $125,000 for 2012, and the phase-out threshold amount was lowered to $500,000. The inflation-adjusted amounts for 2012 are $139,000 and $560,000, respectively (Rev. Proc. 2011-52).

    The Sec. 41 research and development credit also expired at the end of 2011, as did the work opportunity tax credit (Sec. 51(c)) (but portions were extended through 2012 for certain veterans by the Three Percent Withholding Repeal and Job Creation Act).

    Various other tax credits aimed at businesses also expired:

    • The credit for plug-in electric vehicles (Sec. 30);
    • The biodiesel and renewable diesel fuel credits (Sec. 40A);
    • The new markets tax credit (Sec. 45D);
    • The new energy-efficient homes credit (Sec. 45L);
    • The energy-efficient appliances credit (Sec. 45M);
    • The alcohol fuel mixture, biodiesel, alternative fuel, and alternative fuel mixture excise tax credits (Secs. 6426 and 6427); and

    Expired deductions and special depreciation rules (in addition to the expiration of 100% bonus depreciation) include:

    • 15-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements (Sec. 168(e)(3)(E));
    • Charitable deduction for food inventory contributions (Sec. 170(e)(3)(C));
    • Increased charitable deduction for contributions of book inventory to public schools (Sec. 170(e)(3)(D));
    • Increased charitable deduction for corporate contributions of computer equipment to schools (Sec. 170(e)(6));
    • Special film and television production expensing rules (Sec. 181);
    • Brownfields environmental remediation expensing (Sec. 198);
    • The deduction for domestic production activities in Puerto Rico (Sec. 199(d)(8)).

    There are many other expiring business provisions that are not covered in this article due their obscure nature.

    STAY TUNED

    Whatever Congress ends up doing, many of these tax provisions will affect the upcoming tax season. The IRS will need to program its computers and possibly redesign tax forms. The later in the year legislation is passed, the harder it will be for the IRS to have everything in place. And it is possible that Congress will not resolve things until sometime in 2013, leading to retroactive reinstatement of tax provisions and many amended returns.

    Parts of the impending cliff, of course, go beyond taxes: As a result of the debt ceiling agreement reached last year, automatic government spending cuts are scheduled to take effect in 2013. The Supreme Court’s upholding of 2010’s health care legislation and Obama’s re-election means many health care reforms (and some taxes) will go into effect over the next few years. Together, these issues will have a large impact on all taxpayers.

    This is a confusing mess for everyone when the tax laws continually change, but that has been the norm since 1913 when the income tax was first put in place.  We at Widget Bookkeeping and Tax, PA do our best to stay on top of the law changes so we can ensure our clients are paying the lowest amount of tax possible.  We would love to discuss your tax situation with you and help you pay less.

     

    Widget Bookkeeping and Tax, P.A.

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  • The Tax System explained using...BEER!!

    08 October 2012 / Uncategorized / Comments Off on The Tax System explained using...BEER!!

    The Tax System explained using...BEER!!

    The tax system, and how it affects the rich and poor, is often a misunderstood concept.  I recently came across a little story that I fell in love with because it does a fantastic job of accurately describing how the the tax system works for both rich and poor and who benefits from a tax break.  Please read and be prepared to laugh and, finally, understand!!

    ---

    Suppose that every day, ten men go out for beer and the bill for all ten comes to $100.  The men decided to pay their bill the way we pay our taxes, which went something like this…

    The first four men (the poorest) would pay nothing

    The fifth would pay $1

    The sixth would pay $3
    The seventh would pay $7
    The eighth would pay $12
    The ninth would pay $18

    The tenth man (the richest) would pay $59
    The ten men drank in the bar every day and were happy with the arrangement, until one day, the owner threw them a curve ball -  “Since you are all such good customers,” he said, “I’m going to reduce the cost of your daily beer by $20″. From $100 to $80.
    The group still wanted to pay their bill the way we pay our taxes. So the first four men were unaffected. They would still drink for free. But what about the other six men?  How could they divide the $20 windfall so that everyone would get his fair share?

    The bar owner suggested that it would be fair to reduce each man’s bill by a higher percentage the poorer he was, to follow the principle of the tax system they had been using, and he proceeded to work out the amounts he suggested that each should now pay.  And so…

    The fifth man, like the first four, now paid nothing                   (100% savings).
    The sixth now paid $2 instead of $3                                          (33% savings).
    The seventh now paid $5 instead of $7                                     (28% savings).
    The eighth now paid $9 instead of $12                                      (25% savings).
    The ninth now paid $14 instead of $18                                     (22% savings).
    The tenth now paid $49 instead of $59                                     (16% savings).
    Each of the six was better off than before. And the first four continued to drink for free. But, once they left the bar, the men began to compare their savings.

    “I only got a dollar out of the $20 saving,” declared the sixth man. He pointed to the tenth man, “but he got $10!”

    “Yeah, that’s right,” exclaimed the fifth man. “I only saved a dollar too. It’s unfair that he got ten times more benefit than me!”

    “That’s true!” shouted the seventh man. “Why should he get $10 back, when I got only $2? The wealthy get all the breaks!”

    “Wait a minute,” yelled the first four men in unison, “we didn’t get anything at all. This new tax system exploits the poor!”

    The nine men surrounded the tenth and beat him up.

    The next night the tenth man didn’t show up for drinks so the nine sat down and had their beers without him. But when it came time to pay the bill, they discovered something important. They didn’t have enough money between all of them for even half of the bill!

    And that is how our tax system works. The people who already pay the highest taxes will naturally get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up anymore!

  • Independent Contractors vs. Employees? - IRS is becoming VERY interested!!

    25 September 2012 / Uncategorized / Comments Off on Independent Contractors vs. Employees? - IRS is becoming VERY interested!!

    Should your independent contractors really be employees?

    The IRS, U.S. Department of Labor, and state governments have a big stake in correctly classifying workers. Improper treatment of workers as independent contractors costs the government tax revenue, in the form of lost withholding, unemployment, workers’ compensation, and Social Security and Medicare taxes. This opportunity for reclaiming lost revenue has led to increased compliance efforts.

    How big is the issue?

    Even with the interest in proper classification, it is not clear how many workers are misclassified. According to U.S. Bureau of Labor Statistics, contractors made up 7.4% of all workers in 2005—equating to 10.3 million workers. With the recent economic stress on small businesses, the use of contractors has increased significantly since 2005. A 2011 MBO Partners study found that about 16 million workers were classified as independent contractors and predicted an even greater use of independent contractors in the next 10 years. After all, independent contractors are about 30% cheaper than employees and come without many burdensome employment rules—compelling incentives for businesses.

    A 2000 Department of Labor (DOL) study revealed that 10% to 30% of all employers misclassify workers. In 2008, the IRS found that even when workers and employers asked the IRS for proper classification, only 3% of the workers in question were independent contractors. However, the IRS does not have current, definitive numbers. The last definitive study on the issue was conducted in 1984 and concluded that 15% of employers misclassified 3.4 million workers as independent contractors.

    The IRS is stepping up worker reclassification efforts, which represent a substantial revenue opportunity. In fact, a 2009 U.S. Government Accountability Office report stated that 71% of IRS worker misclassification examinations result in changes to worker status. The IRS is currently finalizing a three-year National Research Program initiative that included random audits of 6,600 employers. The study will quantify levels of worker misclassification, and the IRS and many states expect the study to reveal significant noncompliance.

    What will reclassifying workers do?

    The IRS knows that it is easier to keep employees compliant than independent contractors. The latest IRS tax gap study shows that Form W-2 employees misreport only 1% of their income, while, on average, independent contractors misreport 8% of their income. For the IRS, employee status means more automated, less expensive post-filing compliance activity, such as underreporter notices.

    Employee status is even more important in light of Obamacare, which mandates that employers with at least 50 full-time employees provide health care insurance or pay a stiff penalty. Assuming it is not repealed by Romney & Ryan, the mandate will go into effect in 2014, but employers may already be trying to reduce payrolls to avoid new taxes and requirements under Obamacare. One way employers may reduce payrolls is by treating workers as independent contractors, rather than employees.

    Worker reclassification has also been of interest to the Obama administration. In 2011, the DOL confirmed its commitment to use audit and enforcement resources to address the growing problem of employee misclassification. There is also a coordinated effort among the IRS, DOL, and many states to share audit findings and pool resources to address worker classification. At the 2012 IRS Tax Forum, held from July 31 to Aug. 2 in Las Vegas, IRS officials said that the IRS is coordinating employment tax examination findings with 37 states.

    Settlement Programs

    Despite the problem, the IRS does not have a clear, bright-line test to determine the proper classification of workers. Traditionally, the IRS has used the 20 common law factors found in Rev. Rul. 87-41 to test whether a worker is an independent contractor or an employee. Over the years, the IRS has tried to simplify determinations without much success. To complicate matters further, since 1978, IRS worker reclassification efforts have been hampered by defenses under Section 530 of the Revenue Act of 1978, which provided employers with safe harbors, such as reliance on a prior IRS audit or a long-standing industry practice.

    As a result, reclassification audits often led to long disputes in IRS appeals offices. To combat the enforcement stalemates, in 1996, the IRS instituted an early resolution program that could be used to settle audit disputes. The Classification Settlement Program (CSP) allowed for prospective treatment of workers as employees but limited the taxes owed due to reclassification.

    In 2011, the IRS began the Voluntary Compliance Settlement Program (VCSP), which allows an employer to seek prospective treatment for workers and pay even less than under the CSP arrangement, but the program is purely voluntary. It is not available for taxpayers in an employment tax audit conducted by the IRS, DOL, or state agencies. Since the program started, the IRS has received only 625 applications, according to officials at the 2012 Carolinas Tax Forum, held Aug. 8–10 in Charlotte, N.C.

    Practitioners may be concerned about legal ramifications for their clients if they voluntarily supply information involving potential noncompliance. However, the IRS states that the VCSP offers audit amnesty. An IRS official at the 2012 IRS Tax Forum explained further that the IRS will not share VCSP applications with any other federal or state agencies and that employee treatment is prospective and does not imply that the contractor was an employee in the past.

    What can you do?

    As federal and state agencies continue to address worker misclassification, there are three proactive reviews you can conduct to identify risks and reduce your exposure:

    Review Form 1099 recipients for proper classification. Investigate who controls the worker. If you are in control, based on an objective analysis of the 20 common law factors, then you should be treating the worker as an employee. Use Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, to guide your fact gathering of any workers in question. Also, look for inconsistencies in your workforce, including similar workers with different classifications. If you have to reclassify a worker or a group of workers, the VCSP is an option that can soften the blow.

    Review workers who received Form W-2 in the past but are now treated as contractors. These workers are of particular concern because they do not qualify for the VCSP. You must have a clear, documented explanation for the change in treatment. Also, review workers who receive Forms 1099 and W-2 in the same year.

    Review your vendor list, check register, and accounts payable to determine whether you filed a Form 1099 or W-2. Here you may find real exposure. If you fail to file the required information statements altogether and to withhold required taxes, you can become fully liable for the taxes associated with unreported payments and will be subject to failure to file penalties. You can also be subject to penalties for failing to provide a copy of the return to the payee. If the IRS finds that you willfully failed to file the information returns, higher penalties apply.

    It is a good time to conduct a workforce review for your company. Even if the IRS or other agencies take issue with your assessment, the analysis can help demonstrate that any misclassifications were not willful and that you are taking steps to comply.

    If you would like assistance in the analysis, need more information on the 20 factor formula, or any other questions, please feel free to give Widget a call.  We are here to help you!!

  • Timely mailed = Timely filed? Right? WRONG...even using FedEx!!

    12 September 2012 / Uncategorized / Comments Off on Timely mailed = Timely filed? Right? WRONG...even using FedEx!!

    Everyone has heard of the "timely mailed = timely filed" rule, otherwised known as the postal service rule, whereby if your return, payment or other filing is due on April 15th, then it needs to be handed over to the post office by 23:59:59 on April 15th to be considered timely filed.

    However, in an UNBELIEVABLE court decision, taxpayers who chose the wrong type of FedEx delivery service did not get the benefit of the timely mailing/timely filing rule and as a result had their petition dismissed by the Tax Court.  For you individuals that want to review the case -- Scaggs, T.C. Memo. 2012-258.

    The taxpayers had filed a petition in Tax Court challenging an IRS notice of deficiency. The 90-day period to file the petition expired on July 7, 2011, and although the petition was sent by that date, it was not received by the Tax Court until July 12, 2011.

    Under Sec. 7502(a), a timely mailed petition is treated as timely filed as of the date of the U.S. postal service postmark on the envelope in which the petition was mailed, and under Sec. 7502(f), petitions sent using designated private delivery services get the benefit of this rule. However, the taxpayers sent their petition via FedEx Express Saver Third Business Day delivery service, which is not one of the private delivery services specifically designated by the IRS in Notice 2004-83 (although several other FedEx delivery services are, including FedEx 2 Day).

    As a result, the Tax Court dismissed the petition for not being timely filed. Although the Tax Court admitted that the dismissal seemed “harsh,” it noted that it could not apply equitable principles to cure a lack of jurisdiction and that the taxpayers do have a chance at a judicial remedy if they pay the tax and then sue for a refund.

    Next time, this taxpayer won't cheap out and will spring for "overnight service"!!!

  • Why it's important to tax plan in the last quarter of 2012!!

    26 August 2012 / Uncategorized / Comments Off on Why it's important to tax plan in the last quarter of 2012!!

    Tax planning in the last quarter of 2012 is important!

    As any of Widget's clients know, we always recommend a planning meeting in the last quarter.  Widget does charge for this meeting, but at $100 per hour,with most meetings lasting between an hour and two, it is made to NOT break the bank, and this article discusses why this meeting is of vital importance!

    Where are we now?

    As the end of calendar 2012 and the November elections approach, the political debate over tax rates and which group of individuals is currently bearing their “fair share” of the tax burden is intensifying. Following is a brief overview of the history of our current federal rate system and why the current rates will expire absent congressional action. In addition, this article reviews the federal tax increases resulting from the new health care taxes. In short, taxpayers making more than $250,000 (married filing jointly (MFJ)), or $200,000 (single), may experience 2013 marginal tax rate increases ranging from 13% to 189%—depending on the character of the income (NO...that is NOT a typo!!)

    How did we get here?

    The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) was signed by President George W. Bush. EGTRRA lowered tax rates and simplified retirement and qualified plan rules. Some of the major tax areas affected included income tax, capital gains tax, qualified retirement plans, educational savings incentives, and estate and gift tax. EGTRRA was estimated as a $1.3 trillion tax cut over the initial 10-year period.

    Subsequently, Congress passed the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). JGTRRA increased the basic alternative minimum tax (AMT) exemption amount to $58,000 (MFJ) and $40,250 (single). It also established a maximum rate of 15% applicable to long-term capital gains and dividend income. JGTRRA reduced overall taxes by an additional $350 billion over 10 years.

    Together, EGTRRA and JGTRRA have become known as “the Bush tax cuts.” Some of the more significant 2001 and 2003 tax breaks were as follows:

    •Personal income tax rates dropped from a top rate of 39.6% to 35% (taxable income at or above $311,950 MFJ or single taxpayers);

    •“Qualified dividend income” rates dropped from a maximum of 39.6% to 15%; and

    •Maximum long-term capital gains tax rates generally dropped from 20% to 15%.

    The 2001 and 2003 tax cuts were set to expire at the end of 2010; however, due to the 2008 debt crisis and languishing economy, these provisions were extended by Congress for two additional years under the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, which was signed by President Barack Obama in December 2010.

    How does Obamacare complicate things?

    In addition to the already scheduled income tax rate increases, Obamacare, which is more formally known as The Patient Protection and Affordable Care Act (PPACA) imposes, beginning in 2013, an additional 0.9% Medicare hospital insurance tax (HI tax) that will apply to wages or self-employment income of individuals with earnings exceeding $250,000 (MFJ), $200,000 (single), or $125,000 (married filing separately (MFS)). Futher, the PPACA will impose a new 3.8% “net investment income tax” on unearned income for individuals exceeding these same income thresholds. This 3.8% tax is on top of any tax rate increase in dividends, capital gains, and ordinary income.

    The 3.8% tax will not apply to certain types of income, including qualified plan distributions or income from the disposition of “active” LLCs, partnerships, and S corporations. “Active” trade or business income will generally not be subject to the 3.8% net investment income tax (Sec. 1411(c)(2)). These higher rates apply to taxable income of trusts with undistributed net income in excess of the dollar amount at which the highest tax bracket for trusts begins ($11,650 in 2012).

    A summary of the current and future rates are reflected in the following chart:

    Income   Type

    Maximum   Marginal Tax Rate

    Maximum   Marginal Tax Rate

    New   Medicare Hospital Insurance tax (HI tax)*

    New   Net Investment Income Tax (other than earned income)*

    Combined   Maximum Marginal Tax Rate

    Net   Percentage Increase

    Current   Law (Pre-1/1/13)

    (Post-12/31/12)

    (Post-12/31/12)

    (Post-12/31/12)

    (Post-12/31/12)

    (2013   vs. 2012)

    Wages and S/E income > $250,000   (MFJ)/>$200,000 (Single)

    35%

    39.6%

    0.9%**

    N/A

    40.5%

    15.7%

    Long-Term Capital Gain — Maximum   Rate***

    15%

    20%

    N/A

    3.8%

    23.8%

    58.67%

    Qualified Dividends

    15%

    39.6%

    N/A

    3.8%

    43.4%

    189.33%

    Passive Interest, Rents,   Royalties, Other

    35%

    39.6%

    N/A

    3.8%

    43.4%

    24%

    Flowthrough Income — Active   Trade/Business

    35%

    39.6%

    N/A

    N/A

    39.6%

    13.14%

    Flowthrough Income — Passive   Trade/Business

    35%

    39.6%

    N/A

    3.8%

    43.4%

    24%

    *Health Care Reform Increases >   $250,000 (MFJ) > $200,000 (Single)
    >$125,000 (MFS)

    N/A

    0.9%   tax on earned income and 3.8% tax on investment income

    **The 0.9% HI Payroll is an additional tax that applies to wages and self-employment income in addition to the current 1.45% Medicare and 6.2% Social Security taxes.

    *** Lower capital gains rates apply to taxpayers in the 10% and 15% ordinary income brackets and to certain assets with holding periods over five years.

    So, what can I do?

    If Congress does not take any action before the end of 2012, year-end tax planning will present many challenges (and opportunities) for taxpayers, especially high-net-worth individuals. Contrary to traditional year-end planning, certain high-income taxpayers may want to consider accelerating income into 2012 rather than deferring income into the probable higher tax rates of 2013.

    While the tax landscape will not come into clear focus until closer to year end, business owners and high-income individuals need to begin planning for the current year end.

    For those taxpayers anticipating that they will fall into a higher tax rate in 2013, there are a number of tax planning ideas for 2012 year end:

    •As of Jan. 1, 2013, qualified dividends will be subject to ordinary income tax rates (an increase from 15% to up to 43.4% (including the new 3.8% Medicare tax). Accordingly, C and S corporations with excess earnings and profits (E&P) should consider making dividend payments before the end of 2012. Cash-poor corporations can also consider making either a cashless “deemed dividend” by year end under Sec. 1368(e)(3) and Regs. Sec. 1.1368-1(f)(3) for S corporations or a “consent dividend” under Sec. 565 for C corporations.

    •Taxpayers may want to accelerate the recognition of capital gains into 2012 instead of deferring the gains to future years, e.g., by selling appreciated stocks, bonds, real estate, and other assets held more than one year.  This means that people considering tax-free exchanges under Sec. 1031 may want to think twice.

    •Advance planning is also necessary to mitigate the AMT, which affects millions of mid-to-high income taxpayers and kicks in for AMT income (AMTI) of $150,000 (MFJ) and $112,500 (single). However, once a taxpayer is subject to AMT in a given year, the general tax strategy changes to accelerating taxable income into the AMT year (at a 26% to 28% top marginal AMT rate) and deferring tax deductions into a non-AMT year because the regular tax marginal rates are often higher.

    •Other acceleration strategies for both “regular” and AMT individual taxpayers include exercising stock options; taking bonuses in 2012 vs. deferring; forgoing Sec. 1031 (like-kind exchanges) and/or Sec. 1033 (involuntary conversion) elections; and electing out of installment sales.

    •Tax deductions that taxpayers who own businesses may want to consider pushing into a higher tax year after 2012 include pension/retirement plan funding allocations, which are highly flexible between years; employee and owner bonuses; and timing and elections for asset purchases, such as Sec. 179 “expensing” elections; and not electing 50% “bonus” depreciation for 2012 (to increase depreciation deductions in later years). Evaluating accounting periods and methods may also yield benefits.

    •With the 3.8% net investment income tax on the horizon for 2013, taxpayers with a variety of business interests should be planning to ensure that characterization of activities as “passive” or “active” is optimal for minimizing the regular income tax, the 3.8% tax, and payroll taxes.

    •Finally, with estate and gift tax rates rising from the current 35% maximum rate to 55% and the lifetime exclusion amount decreasing to $1 million beginning in 2013 (down from the $5.12 million amount for 2012), a thorough estate plan review should also be undertaken before year end.  We can recommend a Estate Planning attorney to assist you with this complicated and ever-changing portion of the tax law.

    Conclusion

    Current and forthcoming political and economic events make it difficult to determine if the Bush tax rates will be extended again for all, or only some, taxpayers. The outcome of the upcoming presidential and congressional elections will strongly influence the direction of both the short-term and long-term U.S. tax system.

    Please contact us anytime after October 15th through December 15th to get into the office prior to year end to see how Widget can help you adjust your planning to maximize your tax savigns.  Further, if a question comes up at ANY time, please give us a call.  Tax Planning is something that has to be done BEFORE you pull the trigger on something; after is too late to help!

  • Is Office Artwork Depreciable Property?

    23 August 2012 / Uncategorized / Comments Off on Is Office Artwork Depreciable Property?

    Is Office Artwork Depreciable Property? 

    Many offices contain artwork to make customers feel comfortable and to give the business an air of success.  Or they could be there just because the decorator said they were necessary.  Whatever the reason, our clients often ask whether their art is depreciable for tax purposes.  The answer, similar to the answer to most tax deduction questions, is the ever-popular,  “It depends.”

    Let’s assume that a taxpayer remodeled their offices, purchasing new furniture, computer and telephone equipment, and artwork. Further assume that the taxpayer spent a significant sum on the artwork, some from local galleries, some directly from freelance artists, and others from the furniture store and Wal*Mart, with the prices of these pieces of art ranging from $50 to $5,000.  All items were hung up on the wall by the taxpayer.

    Whether the art is depreciable primarily depends on the taxpayer’s answer to the following question: “Is any of the artwork considered ‘valuable and treasured’?”

    In order to understand why it boils down to this one question, it is helpful to review some history on this issue:

    The Background Behind Artwork Depreciation

    In 1968 the IRS issued Revenue Ruling 68-232, which states, in part: “A valuable and treasured art piece does not have a determinable useful life.   While the actual physical condition of the property may influence the value placed on the object, it will not ordinarily limit or determine the useful life.  Accordingly, depreciation of works of art generally is not allowable.”

    This ruling has become the standard for whether office artwork is depreciable; however, the IRS has been fairly silent since then and has provided no guidance on what constitutes a valuable and treasured work of art.

    In 1968, when the IRS issued Revenue Ruling 68-232, depreciation was determined under IRS Code Section 167, which required taxpayers’ to establish the property’s cost basis, useful life, and salvage value in order to calculate depreciation for property used in a taxpayer’s trade or business.  Based on the law in 1968, the IRS’s position with respect to valued and treasured artwork made perfect sense. It would be difficult to establish a useful life for valued and treasured pieces of art that were already hundreds of years old. Especially because valued and treasured artwork would be expected to appreciate in value.

    However, the depreciation rules have undergone two significant amendments since 1968.  Congress has amended the law (now governed by Section 168) to establish the modified accelerated cost recovery system (MACRS).  Under MACRS, an asset’s useful life is no longer the time period used for calculating the amount of depreciation, but instead established a seven-year recovery period for that do not have class lives.

    Therefore, it would appear that a taxpayer no longer has to establish a class life for property to depreciate it under MACRS.  Instead, the taxpayer needs to establish all four things with respect to the property:

    1. It must be tangible property not subject to amortization or another method of depreciation.
    2. The property must have been placed in service after 1986.
    3. It must be subject to exhaustion, wear and tear, or obsolescence.
    4. It must be used in a trade or business.

     

    The third item is the one that may be difficult to prove to the IRS’ (and the courts’) satisfaction, however, as this is an “or” test, if any one of the three conditions exists, the taxpayer meets the third criterion. It is most likely that artwork will not be exhausted, which implies that the property is used up or consumed in the ordinary course of its function.  Also, since beauty is in the eye of the beholder, it may be difficult to argue that artwork becomes obsolete, thus the taxpayer will need to prove that the artwork is subject to wear and tear.

    Again the IRS is not much help because they have failed to set forth a standard of what constitutes wear and tear.  The IRS could argue that because artwork only hangs on a wall or sits on a floor or shelf as a display, it is not subject to wear and tear; however, the curator of any museum would say that all artwork deteriorates over time.

    What do the courts say?

    A Tax Court case often cited by the IRS to defend disallowing depreciation deductions is Associated Obstetricians and Gynecologists P.C., T.C. Memo. 1983-380. In this case the taxpayer, a doctors’ office, displayed various pieces of art in its offices, claimed depreciation on said artwork, which the IRS disallowed. At trial the IRS argued that the works of art did not have a useful life, based on Revenue Ruling 68-232. The court held in favor of the IRS, but noted that Revenue Ruling 68-232 was not applicable because the paintings in question “were more wall decorations than works of art.” (Note that the cost of the objects ranged in price from $40 to $7,000, and the years at issue were 1976 and 1977.) The court also stated, “The paintings could be depreciated if petitioner established their economic useful life and salvage value.” As noted, the tax years at issue were prior to the amendment of the depreciation rules.

    In Simon, 103 T.C. 247 (1994), the IRS argued that violin bows used by the taxpayers in their trade or business of being orchestra musicians could be depreciated only if the taxpayers could establish a useful life for the property.  The IRS argued that the bows were treasured works of art that appreciated in value and for which it was impossible to determine useful lives.  In its opinion, the Tax Court got around Revenue Ruling 68-232 by concluding that the bows were not works of art, but assets used actively, regularly, and routinely to produce income in the taxpayers’ business. The court focused on one issue: “Were the bows property of a character subject to exhaustion, wear and tear, or obsolescence?” If they were, then the taxpayers' could depreciate them.

    Therefore, if artwork is not “valuable and treasured” (as specified in Revenue Ruling 68-232), and the taxpayer can establish that the artwork is subject to wear and tear, depreciation should be allowed on the assets.

    In Selig, T.C. Memo. 1995-519, the Tax Court addressed whether the taxpayer could depreciate certain high-technology “exotic cars” the taxpayer had placed in service in its trade or business by exhibiting them to the public for an admission fee. The taxpayer maintained the cars were subject to obsolescence and therefore were depreciable. Again, the IRS sought to disallow the deduction on the basis that the taxpayer could not establish a useful life for the vehicles.  The Tax Court said the cars’ state-of-the-art character supported the taxpayer’s argument they were subject to obsolescence and stated, “The fact that petitioners have failed to show the useful lives of the exotic automobiles is irrelevant.”

    This case is significant for holding that establishing a useful life was not a determining factor for claiming depreciation, and it dealt with tax years under current Section 168 (MACRS). The court stated that although Congress extensively revised Section 168, “there is no indication . . . that Congress intended...that a taxpayer must show the useful life of property if the taxpayer is to determine the section 167 depreciation deduction under section 168.”

    With respect to Simon and other cases, the IRS has indicated its non-acquiescence to those decisions.

    Conclusion

    It would appear that recent case law is favorable to the proposition that all artwork, “valued and treasured” or not, is subject to the allowance for depreciation under Internal Revenue Code Section 168 if the taxpayer can meet the four requirements described above. But the taxpayer most likely will continue to be in for a fight if the IRS examines its tax return. The taxpayer should be prepared to establish the business reasons for the acquisition of the artwork to meet the “used in a trade or business” standard. The taxpayer also should be prepared to establish that the items are subject to wear and tear or obsolescence in their use.  Obviously, the more expensive the artwork, the more likely it is that an agent will disallow a claim of depreciation expense with respect to the item.

    We at Widget hope you have found this article informative and interesting.  If you have questions on the depreciation of artwork, or any other issues, please feel free to give Widget a call.  We are here to help!!

  • Answers to Frequently Asked Questions for Same-Sex Couples

    31 July 2012 / Uncategorized / Comments Off on Answers to Frequently Asked Questions for Same-Sex Couples

    Answers to Frequently Asked Questions for Same-Sex Couples

    The law in many states now allows for same-sex marriages.  As state law allows something that federal law does not allow, this causes a host of issues when it comes to tax time!

    The following questions and answers provide some guidance for same-sex domestic partners, same-sex individuals in civil unions and same-sex couples whose marriage is recognized by state law (for convenience, these individuals are referred to as “same-sex couples” and each individual is referred to as a “same-sex partner” in these questions and answers). Below this information are questions and answers for same-sex couples who reside in community property states and are subject to their state’s community property laws:

    • Q. Can same-sex partners who are legally married for state law purposes file federal tax returns using a married filing jointly or married filing separately status?
    • A. No. Same-sex partners may not file using a married filing separately or jointly filing status because federal law does not treat same-sex partners as married for federal tax purposes.
    •  Q. Can a taxpayer use the head-of-household filing status if the taxpayer’s only dependent is his or her same-sex partner?
    •  A. No. A taxpayer cannot file as head of household if the taxpayer’s only dependent is his or her same-sex partner. A taxpayer’s same-sex partner is not one of the related individuals described in the law that qualifies the taxpayer to file as head of household, even if the same-sex partner is the taxpayer’s dependent.
    • Q. If a child is a qualifying child of both parents who are same-sex partners, which parent may claim the child as a dependent?
    • A. If a child is a qualifying child of both parents who are same-sex partners, either parent, but not both, may claim a dependency deduction for the qualifying child. If both parents claim a dependency deduction for the child on their income tax returns, the IRS will treat the child as the qualifying child of the parent with whom the child resides for the longer period of time. If the child resides with each parent for the same amount of time during the taxable year, the IRS will treat the child as the qualifying child of the parent with the higher adjusted gross income.
    •  Q. Can a same-sex partner itemize deductions if his or her partner claims a standard deduction?
    •  A. Yes. A same-sex partner may itemize or claim the standard deduction regardless of whether his or her partner itemizes or claims the standard deduction. Although the law prohibits one spouse from itemizing deductions if the other spouse claims the standard deduction (section 63(c)(6)(A)), same-sex partners are not spouses as defined by federal law, and this provision does not apply to them.
    •  Q. If a same-sex couple adopts a child together, can one or both of the same-sex partners qualify for the adoption credit?
    •  A. Yes. Each same-sex partner may qualify to claim the adoption credit on the amount of the qualified adoption expenses paid or incurred for the adoption. The same-sex partners may not both claim credit for the same qualified adoption expenses, and neither same-sex partner may claim more than the amount of expenses that he or she paid or incurred. The adoption credit is limited to $13,360 per child in 2011. Thus, if two same-sex partners each paid qualified adoption expenses to adopt the same child, and the total of those expenses exceeds $13,360, the maximum credit available for the adoption is $13,360. The same-sex partners may allocate this maximum between them in any way they agree, but the amount allocated to a same-sex partner may not be more than the amount of expenses he or she paid or incurred.
    •  Q. If a taxpayer adopts the child of his or her same-sex partner, may the taxpayer (“adopting parent”) claim the adoption credit for the qualifying adoption expenses he or she pays or incurs to adopt the child?
    •  A. Yes. The adopting parent may claim an adoption credit to the extent provided under the law. The law does not allow taxpayers to claim an adoption credit for expenses incurred in adopting the child of the taxpayer’s spouse. However, this limitation does not apply to adoptions by same-sex partners because same-sex partners, even if married for state law purposes, are not treated as spouses under federal law.
    • Q. Is a same-sex partner the stepparent of his or her partner’s child?
    •  A. If a same-sex partner is the stepparent of his or her partner’s child under the laws of the state in which the partners reside, then the same-sex partner is the stepparent of the child for federal income tax purposes.

    Same-sex couples have many issues that they need to deal with before they even think about thier taxes and the tax treatment of the children they adopt together.  Let Widget help you with these issues and make your life just a little easier!

  • The IRS wants a copy of my canceled check! WHAT DO I DO?

    25 July 2012 / Uncategorized / Comments Off on The IRS wants a copy of my canceled check! WHAT DO I DO?

    The IRS wants a copy of my canceled check! WHAT DO I DO?

    With many taxpayers engaging in electronic banking and debit card transactions (because paying with cash doesn't provide durable proof of deductions, there is no "canceled check" to provide the IRS.  How do we comply with this request?

    First...a little bit of history...

    The Check Clearing for the 21st Century Act (Check 21 Act), P.L. 108-100, was signed into law on Oct. 28, 2003, and went into effect on Oct. 28, 2004.  For most taxpayers, this means that they now receive scanned images of their canceled checks in bank statements rather than the actual canceled checks; in some cases, they are not receiving even those.  However, during an IRS audit, some IRS requests for information insist on substantiating expenditures with front-and-back copies of canceled checks.

    The Check 21 Act enables banks to handle more checks electronically so they can process them more quickly and efficiently as moving paper checks is costly and slow.  When a paper check is first deposited, a picture of the front and back of the check is captured and from then on the image is transmitted electronically.  The Check 21 Act permits banks to provide either the original check or a “substitute check” (defined below) “or, by agreement, information relating to the original check (including data taken from the MICR [magnetic ink character recognition] line of the original check or an electronic image of the original check), whether with or without subsequent delivery of the original paper check” (Check 21 Act, §3(18)).  After doing this, the bank generally is allowed to destroy the original check.

    So what happens when the IRS conducts an examination and asks for a canceled check to substantiate payment of an expense? In the past, the IRS has accepted copies of canceled checks; thus taxpayers had to take extra care to protect the copies of checks that accompanied their bank statements.  For those that no longer receive copies of checks with thier statements (most of us) the bank normally provides access to copies of these checks.

    In rare instances where the IRS demands more than the copy of the canceled check included in the bank statement, taxpayers can request a substitute check from the bank.  A substitute check is legally the same as the original check if it accurately represents the information on the original check and includes the following statement: “This is a legal copy of your check. You can use it the same way you would use the original check” (Check 21 Act, §§4(b)(2), 4(e)).

    If a taxpayer receives a substitute check that is not legally the same as the original check and suffers a loss related to the substitute check, the Check 21 Act provides the taxpayer with a special procedure that can be used for restitution (Check 21 Act, §6(a)).

    The IRS has indicated that it generally will accept photocopies of substitute checks as proof of payment.  However, as has been IRS policy for copies of canceled original checks, if an IRS auditor suspects that the copy is not genuine, he or she may ask the taxpayer to order the actual substitute check from the bank.  The taxpayer’s general recordkeeping obligations under the tax law are satisfied by keeping the bank statements.

    Note that the Check 21 Act procedure is far different from the electronic check conversion process that has been in use for many years, in which a bank customer’s check is converted to an Automated Clearing House (ACH) debit. The money is taken out of an account, or the taxpayer may authorize an electronic check and pay a bill by telephone or online. Customers’ rights using ACH debits and electronic checks are far different from their rights under the Check 21 Act, since the only record of an electronic check may be the notations on the bank statement.

    The key points to remember with the Check 21 Act are:

    • If a taxpayer is receiving canceled checks now, that will continue until the bank sends notification to the contrary.
    • If taxpayers have online access to bank statements, they should download and save the electronic copy of the statements and checks as a backup.
    • Banks are not required to keep original checks for any specific length of time, and the Check 21 Act does not add any retention requirement.
    • Banks are required to notify customers if they change the way they have been providing canceled checks or copies.
    • Banks may provide a substitute check but are not required to do so.  Customers need to understand what their bank will provide.
    • Even if the bank does provide a substitute check with the proper language, it may charge for this service.

    If you have any questions on this or any other recordkeeping, bookkeeping or tax issue, please give Widget a call.  We are here to help!!

  • Job Search Expenses CAN BE DEDUCTIBLE!!

    18 July 2012 / Uncategorized / Comments Off on Job Search Expenses CAN BE DEDUCTIBLE!!

    Job Search Expenses CAN BE DEDUCTIBLE!!

    Summertime is the season that often leads to major life decisions, such as buying a home, moving or a job change. If you are looking for a new job that is in the same line of work, you may be able to deduct some of your job hunting expenses on your federal income tax return.

    Unfortunately the IRS does limit these expenses by a) only allowing you to claim them IF you itemize and b) only allowing them IF they exceed a certain dollar threshold;  but if you can meet the requirements, it's a little more cash in your pocket right when you need it the MOST!

    Here are seven things to know about deducting costs related to your job search:

    1. To qualify for a deduction, your expenses must be spent on a job search in your current occupation. You may not deduct expenses you incur while looking for a job in a new occupation.

    2. You can deduct employment and outplacement agency fees you pay while looking for a job in your present occupation. If your employer pays you back in a later year for employment agency fees, you must include the amount you received in your gross income, up to the amount of your tax benefit in the earlier year.

    3. You can deduct amounts you spend for preparing and mailing copies of your résumé to prospective employers as long as you are looking for a new job in your present occupation.

    4. If you travel to look for a new job in your present occupation, you may be able to deduct travel expenses to and from the area to which you travelled. You can only deduct the travel expenses if the trip is primarily to look for a new job. The amount of time you spend on personal activity unrelated to your job search compared to the amount of time you spend looking for work is important in determining whether the trip is primarily personal or is primarily to look for a new job.

    5. You cannot deduct your job search expenses if there was a substantial break between the end of your last job and the time you begin looking for a new one.

    6. You cannot deduct job search expenses if you are looking for a job for the first time (sorry new grads!).

    7. The amount of job search expenses that you can claim is limited. To determine your deduction, use Schedule A, Itemized Deductions. Job search expenses are claimed as a miscellaneous itemized deduction and the total of all miscellaneous deductions must be more than two percent of your adjusted gross income.

    For more information about job search expenses, other deductions, or any other tax or accounting matter, please feel free to give us a call to discuss!  We at Widget are here to help you!

  • Charitable Contribution DENIED!

    21 May 2012 / Uncategorized / Comments Off on Charitable Contribution DENIED!

    Charitable Contribution DENIED!

    The amazing result in this case shows why paying attention to the formalities that your CPA hounds you about is critically important should the IRS ever come and want to see the proof.  When dealing with the IRS truth doesn't matter.  It's ALL ABOUT THE PROOF!

    In 2007, Mr. & Mrs. Durden, being good, honest Christian church-goers dutifully contributed their 10% tithe of $22,517 to their church. Although the church provided them with a timely statement acknoweldging the $22,517 contribution, it did not state whether they had received any goods or services as required by Internal Revenue Code Section §170(f)(8)(A).  After being notified by the IRS of this deficiency, the Durdens did what any taxpayer in the same situation would do; they obtained another statement from the church acknowledging the $22,517 contribution which included the required verbiage about receiving no goods or services.

    The  IRS continued to deny the deduction because thier position was that both acknowledgments failed the requirements to deduct charitable contributions under Internal Revenue Code Section §170(f)(8)(A):

    (1) the first acknowledgment did not include the required goods or services statement; and

    (2) the second acknowledgment was not contemporaneous within the meaning of Internal Revenue Regulation § 1.170A-13(f)(2) because it was not received by the Durdens before they filed their 2007 tax return.

    The Tax Court accepted the IRS’s position and the Durdens conceded that they did not strictly comply with the statute, and the Tax Court rejected their attempt to prove substantial compliance.

    This error, BY THE CHURCH, which the taxpayers failed to catch, cost them over $10,000 in tax, penalties and interest.  You can read the court case for yourself at http://www.ustaxcourt.gov/InOpHistoric/DurdenMemo.TCM.WPD.pdf

    Don't let this happen to you!!  If you should need any assistance with what the Internal Revenue Service requires for substantiation of any deduction from charitable contributions to meals & entertainment to auto expenses or travel, please give Widget a call.

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