Planning for Taxes in an Uncertain Environment

James F. Knight, CPA

• “This is a question too difficult for a mathmatician. It should be asked of a philosopher”.– Albert Einstein, about filling out his tax form in

1944

What we’ll talk about

• Expiration of President Bush’s 2001 & 2003 tax cuts

• Immediate(1/1/13) impact of the Patient Protection and Affordable Care Act (PPACA) & Health Care and Education Reconciliation Act of 2010 (HCERA)

• Long-term implementation of PPACA & HCERA

Expiration of Bush tax cuts

• Originally extended in December of 2010• Set to expire December 31, 2012

– Political uncertainty vs. conventional wisdom

Expiration of Bush tax cuts

• Some key notable changes include;– Top rates increase from 33% to 36% and from

35% to 39.6%– Top long-term capital gains tax rate will

increase from 15% to 20%– Qualified dividends will no longer be subject

to preferred tax rate of 15%. They will be subject to ordinary tax rates.

Expiration of Bush tax cuts

• Some key notable changes include;– Itemized deductions will again be phased out

by the lesser of (a) 3% of the excess of adjusted gross income over an applicable amount or (b) 80% of the amount of the itemized deductions otherwise allowable for such taxable year.

Expiration of Bush tax cuts

• Some key notable changes include;– Estate, gift and generation-skipping transfer

tax exemptions will be reduced from $5.12 million to $1million and maximum transfer rates will increase from 35% to 55%

2013 Impact of PPACA

• Key Provision– Addition of FICA Hospital Insurance Payroll

Tax• High-income earners will be subject to an

additional payroll tax of 0.9% on wages received in excess of the following threshold amounts;

– Married filing jointly - $250,000– Married filing separately -$125,000– Single or head-of-household - $200,000

2013 Impact of PPACA

– Addition of FICA Hospital Insurance Payroll Tax• FICA (Federal Insurance Contributions Act)

– Social Security portion (4.2% of wages up to $110,000)– Medicare portion (1.45% on all wages)

» Employer “match” -6.2% SS, 1.45% Medicare

• New 0.9% added to Medicare tax on wages earned in excess of the applicable threshold amounts for a combined employee Medicare rate of 2.35%

Addition of FICA Hospital Insurance Payroll Tax

• The additional tax applies to wages and self-employment income

• It will not be adjusted for inflation• It will not qualify for the above-the-line

deduction for 50% of SE tax.• Need to be considered for estimated tax

purposes.

Addition of the 3.8% Medicare Contribution Tax

• Beginning in 2013, a new 3.8% Medicare tax will be imposed on certain unearned income of individual, trusts, and estates.

• This tax is in addition to any other income taxes a taxpayer may owe.

Addition of the 3.8% Medicare Contribution Tax

• For individuals, the tax is calculated by multiplying the 3.8% rate by the LESSER of;– Net investment income for the year, or – Modified adjusted gross income (MAGI)

exceed the threshold amount

Addition of the 3.8% Medicare Contribution Tax

• Net investment income is unearned income including;– Interest, dividends, capital gains– Annuities, rents and royalties– Passive income from a business– Net gain on the sale of a principal residence

in excess of the current exclusion amounts– Gain on the disposition of passive activity

property

Addition of the 3.8% Medicare Contribution Tax

• Net investment income does NOT include;– Pension, IRA, Profit sharing plan distributions– Tax-exempt income– Income subject to self-employment tax– Royalties from oil and gas production, with

exceptions

Addition of the 3.8% Medicare Contribution Tax

• Lessor of Net investment income or MAGI over the threshold amounts;– Married filing jointly - $250,000– Married filing separately - $125,000– Single or head-of-household - $200,000

Addition of the 3.8% Medicare Contribution Tax

• If a taxpayer has net investment income but their MAGI is below the threshold amounts, they will not be subject to the tax

• If a taxpayer has MAGI above the threshold but has no net investment income, they will not be subject to the tax.

Addition of the 3.8% Medicare Contribution Tax

• Example– Harry and Teri, a married couple filing a joint

return, have 2013 MAGI of $350,000 and $60,000 of net investment income.

– They will owe 3.8% medicare contribution tax on $60,000 or $2,280.

Addition of the 3.8% Medicare Contribution Tax

• The MC tax also applies to estates and trusts.– 3.8% applies to the lesser of (a) the

undistributed net investment income or (b) the AGI over the amount at which the highest trust and estate tax bracket begins • Over $11,650 for 2012

– Tax doesn’t apply to trusts that don’t have undistributed income (simple trusts)

Combined effect on tax rates

Source of income 2012Maximum Maximum Total maxumum tax rate Total maximum tax rate if Rates Rates If subject to additional subject to additional 0.9%

3.8% MC Tax FICA-HI taxLong-term capital gains 15% 20% 23.80% N/AQualified dividends 15% 39.60% 43.40% N/AOrdinary income(excluding wages) 35% 39.60% 43.40% N/AWages (includes wage earner's 36.45% 41.05% N/A 41.95%1.45% Medicare payroll tax)

2013

Strategies in anticipation of higher rates

• Accelerate income– Bonuses, commissions– Convert to a ROTH in 2012

• Not subj to minimum distribution requirements

– Consider exercising nonqualified stock options

– Sell appreciated property prior to year end• Stocks, principal residence, other real estate

Strategies in anticipation of higher rates

• Reset low basis positions– Wash sale rules don’t apply to gains

Strategies in anticipation of higher rates

• Defer income– Increase retirement contributions

• IRA contributions reduce MAGI and future distributions are not considered net investment income

• 401(k) contributions reduce MAGI and wages subject to MC tax

• Consider tax-deferred annuities• Life insurance-tax deferred growth free from

current income tax and MC tax.

Strategies in anticipation of higher rates

• Reduce income– Municipal bonds– Growth investments– Consider gifting assets that produce net

investment income

Estate planning strategies

• Take advantage of current $5.12 million exclusion– Important even if estate is not in $5 million

range– Consider correcting gifting inequities– Trusts help keep control if beneficiaries not

ready

Business planning

• Expiration of bonus depreciation• Reduction of Sec. 179 limit

– Current $139,000 with $560,000 investment ceiling

– Drops to $25,000 with a $200,000 investment ceiling

• Entity selection to reduce SE tax.

Other effects of the legislation

• 2012 - Disclosure of health benefits on employees W-2

» Supposed to be effective in 2011 but mandator in 2012

Other effects of the legislation

• 2013– Medical expense threshold

» Under 65 –increases to 10% of AGI» Over 65 -remains 7.5%

– Fee imposed on health plans» $1 per covered person in 2013, $2 in 2014

– Maximum flexible spending provision for medical expenses capped at $2,500

Other effects of the legislation

• 2014– Premium assistance credit

• Refundable credit for individuals with HH income between 100% and 400% of federal poverty level.

– Excise Tax on Uninsured• New law requires citizens and legal residents to

maintain minimum health insurance coverage.– Penalties will be greater of 2.5% of amount by which

household income exceeds amount requiring filing of return or $695 per uninsured adult in household

Other effects of the legislation

• Excise Tax on Uninsured(cont’d)– Individuals or employers will be offered a

variety of optional coverage packages with different deductibles, copays, etc. but all offerings will meet federally mandated minimum coverage requirements.

– Federal government will subsidize cost for those with relatively low income.

Other effects of the legislation

• 2014 (cont’d)– Expanded employer/administrator reporting– “Qualified benefit” through exchange

• Individual pays and claims credit or fed pays credit directly to the exchange and individual pays the difference.

– Employer penalty• “applicable large employer” that fails to provide

affordable “minimum essential coverage”

Questions/Comments

• Thank you for being a valued friend of St. Clair CPAs