2012 Tax Outlook

2012 Tax Outlook: "Campaign Heats Up"

The 2012 presidential election already seems like it's been on for years.  President Obama has proposed to raise taxes on those earning above $200,000 ($250,000 for joint filers), including a new surtax on incomes over a million.  Republicans have pledged to cut taxes in hopes of stimulating the economy.  And regardless of who wins in November, the Bush tax cuts are scheduled to automatically expire at the end of this year.

Since taking office, Obama has offered a variety of cuts for lower- and middle-income Americans.  These include new credits for working individuals, expanded breaks for higher education, extended breaks for homebuyers, and even a temporary sales-tax deduction for new car purchases.  While these changes have made taxes more complicated, they've done nothing to stall future tax hikes for higher incomes. 

The new healthcare reform law actually makes it harder to deduct healthcare costs, and imposes significant new taxes on investment income.  With the federal budget deficit topping $1 trillion per year, many observers see the new healthcare taxes as the tip of a looming iceberg. 

 This report summarizes some of the future tax hikes we can expect and offers suggestions for avoiding them where possible.  We look forward to discussing these threats and helping craft the appropriate response! 

 Tax Brackets Stable - For Now!

 Washington has extended the Bush tax cuts, effective for two years through 2012, and Congress shows little appetite for raising rates on middle-income earners. This means that tax on ordinary income is currently capped at 33% and 35% for taxpayers in the highest brackets, and taxes on capital gains and qualified corporate dividends remain capped at 15%.  However, budget deficits continue to balloon out of control, and if Congress can't agree to extend cuts, rates will rise automatically in 2013.

Do you expect your 2013 income to be significantly different than in 2012 (as may be the case if you retire, buy or sell a business, or sell significant investments)?  If so, consider timing income and deductions for maximum tax advantage.

If you expect to earn LESS in 2013, consider delaying some of this year's income (to subject it to tax next year, when you'll be in a lower bracket).  And pay deductible expenses this year, as much as you can.

Or, if you expect to earn MORE in 2013, consider accelerating income from commissions, bonuses, and qualified plan withdrawals into this year (to subject it to tax now, before you move up into a higher bracket next year).  You might also delay paying deductible expenses until next year, to the extent possible.

Itemized Deductions Going Down?

President Obama has proposed limiting the value of itemized deductions to just 28%, even for taxpayers in higher brackets.  This would amount to a "stealth" tax increase and cut the value of deductions for medical expenses, state and local taxes, mortgage interest, and even charitable gifts.

Tax Strategies for Healthcare Costs

Paying for medical care becomes harder every year.  The recent healthcare reform act improves coverage and extends it to more Americans, but actually makes it harder to deduct unreimbursed expenses.  (Under current law, you can deduct medical expenses exceeding 7.5% of your Adjusted Gross Income.  Under the new law, starting in 2013, that floor rises to 10%.)  It also limits contributions to employer-sponsored flexible spending plans to $2,500/year.  

If you're free to select your own coverage, consider choosing a "high-deductible health plan"  and opening a Health Savings Account.  These arrangements bring down premium costs and use pre-tax dollars for out-of-pocket costs, bypassing the floor on AGI.  

If you're self-employed, consider establishing a Medical Expense Reimbursement Plan, or MERP.  These plans let you pay family medical expenses with pre-tax business dollars.  They may even help you avoid self-employment tax.

Audit Odds Still Low

IRS audit odds are increasing, from 1 in 200 returns for 2000 to 1 in 100 for 2009. But your chance of getting audited is still minimal. Don't take low audit rates as an invitation to cheat! But don't let fear of an audit stop you from taking every legitimate deduction you're entitled to.

New Roth IRA Conversion Opportunity

New rules now let you convert your traditional IRA to a Roth IRA, regardless of your current income.  This is actually one of the bright spots of the of the current tax picture. 

Traditional tax planning holds that it makes sense to defer income into retirement accounts now, when you're in your peak earning years (and highest tax bracket) - then withdraw it later during retirement, when your income and tax bracket will presumably be lower.  However, tax rates are currently at historic lows, and it's entirely possible they will be higher when you're retired.  This suggests the smarter strategy may be to pay tax on retirement funds now in order to withdraw them tax-free when rates are higher.

New Tax on Interest Income

The healthcare reform act imposes a new "Unearned Income Medicare Contribution" of 3.8%, beginning on January 1, 2013, on interest income, for taxpayers reporting more than $200,000 ($250,000 for joint filers).  This tax may make municipal bonds and money market funds more attractive relative to fully taxable vehicles.  However, the recession has jeopardized state and local tax revenues, so there may be credit quality issues to consider.  You might also consider deferred annuities and permanent life insurance for fixed-income portions of your portfolio.

New Tax on Dividend Income

Tax on "qualified corporate dividends" is currently capped at 15%, even for taxpayers in the highest brackets.  However, beginning in 2013, the healthcare reform act imposes a new "unearned income Medicare contribution" of 3.8% on dividend income for individuals earning over $200,000 ($250,000 for joint filers).  Consider favoring stocks that pay little or no dividend in taxable accounts and holding stocks paying higher dividends in tax-deferred accounts.

Permanent Life Insurance for Tax-Free Income

As mentioned earlier, the healthcare reform act imposes a new "Unearned Income Medicare Contribution" of 3.8%, beginning on January 1, 2013, on "investment income" (broadly defined to include interest, dividends, capital gains, rents, royalties, and annuity distributions) for individuals making over $200,000 ($250,000 for joint filers).  Permanent life insurance offers a variety of investment options for accumulating cash values, along with tax-free withdrawals and loans so long as you keep the policy in force.

New Tax on Real Estate Income

The healthcare reform act imposes an "unearned income Medicare contribution" of 3.8%, effective starting in 2013, on income from real estate investments and taxable gains from the sale of your primary residence, for individuals making over $200,000 ($250,000 for joint filers).  There are several strategies you can use to minimize taxable real estate income, including favoring tax-deductible "repairs" over depreciable "improvements" and cost segregation strategies to maximize depreciation deductions.

Higher Tax on Capital Gains

Tax on long-term capital gains (from property you hold more than 12 months) is currently capped at 15%, even if your regular tax rate is higher.  However, the recent healthcare reform act also imposes a new "unearned income medicare contribution", beginning in 2013, of 3.8% on capital gains for individuals earning over $200,000 ($250,000 for joint filers).  If you have appreciated assets such as securities, real estate, or a business you'd like to sell, consider doing so before new rates become effective.  Check with us first, to discuss if you can use tax-free exchanges, installment sales, charitable trusts, or similar strategies to minimize or even eliminate tax on those sales.

Uncertainty on Estate Tax

The estate tax actually "died" for 2010.  Washington brought it back to life, with a 35% tax applying on estates over $5.12 million per person.  However, the new system applies only for 2011-2012.  If Washington doesn't act to extend it, the tax reverts to 55% on estates over $1.0 million, beginning January 1, 2013.  This means that smart, flexible estate planning will still be part of most affluent families' plans.

Next Steps

We're sure you appreciate this brief outline of upcoming tax threats.  While smart intelligence is crucial, intelligence alone is useless without the right action.  If the threats we've discussed so far have you worried about your financial future, you owe it to yourself to take a more comprehensive look at your taxes and finances, so that we can determine exactly which concepts and strategies will work from here. 

Any tax advice contained in the body of this presentation was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form. 

Failed Tax Strategies

#1 Delay in Getting Started
Most tax strategies fail because they are delayed in getting started - which often leads to them never getting started.

The time most people think about a tax strategy is usually at the same time they are starting a new business or investment activity.

This is a time when there are a lot of things going on to get the business or investments started.  And, at the same time, cash is usually tight.  The tax strategy gets put on hold temporarily but the temporary status grows into a permanent status.

There are key parts of a tax strategy that have to be planned out before the business or investing activity starts.  When the tax strategy is delayed in getting started, some of the tax saving opportunity could be gone forever.

I hate it when I have to tell a prospective client that we could have reduced their taxes even more had they just started with us sooner.

#2 No Check Up
Most people go to the doctor annually, even if they feel great, to get a check up.  This is usually part of a long term strategy for a long and healthy life.

The same needs to happen with a tax strategy.

Many people set up their tax strategy, work diligently with their CPA for the first year or perhaps even first two years, and then let things slide a little bit.

While it's true that some tax strategies can run themselves to some extent over time, it's never a substitute for checking in with your CPA to determine if there is anything that has changed or can be done differently.

After all, even if nothing has changed in your world, the tax world changes on a regular basis.

#3 The Cost v. Benefit
A successful tax strategy is one that creates tax savings that outweigh the costs of creating the tax savings.

Pretty straightforward concept, but sometimes the facts can be deceiving and that causes many tax strategies to fail.

For example, which is better:
- A tax return that costs $750 to have prepared, or
- A tax return that costs $2,500 to have prepared

If both tax returns produce the exact same tax results, then the lower cost tax return is a great deal.

But, what if that $750 tax return calculated a tax liability that is $5,000 more than had it been prepared elsewhere?  This is where I see many tax strategies fail.  

Have you ever seen the media studies where they take the same tax information to several tax return preparers?  The idea is to see if the results are the same.  The results are never the same!  But, that doesn't necessarily mean any of the tax returns are technically inaccurate.

It's not unusual to have options on how income and deductions can be reported on a tax return and have each option be technically accurate.

This is what is so great about the tax law.  Whether it's the U.S. tax law or elsewhere, there can be many options with how items are reported and with the right tax preparer, it can result in maximizing your tax savings.

How do you know if your tax preparer is maximizing your tax savings?
One way to assess your tax preparer is based on how much information your tax preparer wants to know about you and your activities.

Your tax preparer should ask you tons of questions that help you reveal specific details about your situation that impact your taxes.

Asking questions about your situation is not the same as asking you for your tax information (like your W-2 and financials).  Every tax preparer will ask you for your tax information.

If your tax preparer isn't probing to better understand your situation, then it is very difficult to uncover the different options available for reporting your income and deductions.  The fewer options there are, the more difficult it is to minimize your taxes.

If your tax preparer isn't asking you questions, then that is a strong indicator that they aren't leveraging the options available within the tax law to minimize your taxes.

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form.

Daughter Gets Tax Deduction For Expenses Mom Paid

Judith F. Lang v. Commissioner, TC Memo. 2010-286, December 30, 2010.

Mother paid medical expenses directly to provider, and also paid daughter’s real estate taxes. IRS denied deduction to daughter since the daughter did not pay the expenses. Tax Court ruled that based upon substance over form, the mother had in fact made a gift to the daughter, and the daughter was the payor of the expenses. Hence, the daughter is entitled to the deduction.

In 2006, Judith Lang incurred $27,776 of deductible medical expenses (assumed to be net of the 7½% of AGI limitation), and had $6,840 of real estate taxes.  Her mother, Frances Field, paid $24,559 directly to Judith’s medical providers and paid $5,508 directly to the city to pay for Judith’s real estate tax. Mrs. Field had no obligation to make these payments. Nor did she claim an income tax deduction for these payments.

In order to claim a deduction for medical expenses, the expense must be for the taxpayer, spouse or dependent. Since Judith was not a dependent of Mrs. Field, Mrs. Field could not legally claim a deduction. In order to claim a deduction for real estate taxes, one must be legally obligated to make the payment. Mrs. Field was not.  The second requirement for each of these expenses is that the taxpayer actually make the payment.  It is this second requirement that was the subject of the case.

The IRS argued that Judith did not make the payment, and therefore she could not take the deduction. Judith countered that based upon substance over form, she received a gift from mom, and she was the actual payor of the expenses.

The Court sided with Judith, stating that Mrs. Field did make a gift to Judith and Judith gets credit for making the payment. The Court noted that Mrs. Field’s payments directly to the medical providers meant that, under the gift tax rules, these payments were not taxable gifts. But the Court said that the gift tax rules do not control for income tax treatment. Hence, Judith is entitled to the deduction.

If the IRS position was allowed to stand, then no one would be entitled to a deduction in this case; mom because it wasn’t her obligation, and daughter because she didn’t pay it. The Court seemed to look at this as a situation where SOMEONE should get the deduction, and wisely (in my opinion) decided in favor of Judith.

It should be noted that since the medical payments did not constitute a gift, and the real estate tax payment did not exceed the annual exclusion, there was no gift tax issue. I would suggest that it would not be a bad idea in situations such as this, or similar ones such as a grandparent paying college tuition and  the parent claiming a deduction or credit, that the actual payor file a gift tax return to document that they’ve made a gift to the person obligated to make the payment, so that that person can claim the deduction/credit.

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form.

Deduct Nursing Home Medical Expenses

You can deduct as medical expenses the cost of medical care in a nursing home, home for the aged, or similar institution, for you, your spouse or dependents. This includes the cost of meals and lodging in the home if a principal reason for being there is for medical care. If the reason for being in the home is personal, you can't include the cost of meals and lodging, but you can deduct the part of the cost that is for medical or nursing care.

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form. 

And the Oscar Goes To . . .

Sunday night, the Academy of Motion Picture Arts and Sciences put "Oscar" on a diet, cutting out live performances for "Best Original Song" nominees and trimming the traditionally bloated and self-indulgent awards program to just over three hours. Movies about movies were the big winners. "Hugo," Martin Scorsese's homage to French director Georges Melies, took five awards early in the evening. And "The Artist," a black-and-white silent film celebrating Hollywood history, took home five more, including the coveted "Best Picture."

Host Billy Crystal managed to sneak in a joke about about taxes during the broadcast -- he remarked that the "Harry Potter" movies had grossed over seven billion dollars in worldwide receipts but paid just 14% in taxes! (Apparently that "taxium minimoso" spell is a real winner! It also helps if you can keep your bank records in disappearing ink.) But while the tax man rarely gets a star turn on stage, he still manages to clean up at awards time.

For starters, you know how nominees walk away with fat "swag bags" filled with goodies and bling? Those bags are taxable, of course. This year's bag is valued at $62,023.26 (down a bit from last year's $75,000). It includes little "party favors" like a $135 bottle of Purell hand sanitizer (bagged in a gold and crystal studded carrying case), $120 worth of "earthpawz" environmentally-friendly pet accessories (Dirty Dog Floor Cleaner & Mud Remover, Doggie Slobber Window & Glass Cleaner, Doggie Grime All Purpose Cleaner, Smelly Dog Odor Eliminator and Eco-Tabs Stain & Odor Remover), and a $178.99 "thermarobe" wireless heated robe.

The swag bag also includes bigger-ticket gifts like a $15,580 four-night safari -- on elephant back, no less -- in Botswana, a $15,000 cocktail party for up to 100 guests sponsored by liqueur maker DiSaronno, and a $3,350 stay in an oceanview suite in Punta de Mita on the Mexican Riviera. Some nominees actually refuse the bags to avoid the tax hit, while others -- including A-lister George Clooney -- have donated the contents to be auctioned for charity.

Oscar nominations and Oscar victories give films a famed "Oscar bounce" -- and that means taxable income for everyone involved. "Best Picture" nominees earn an average of $17.7 million after their nomination and another $4 million after the show. Best Picture winners earn $27.5 million after their nomination and $15.4 million after the show. (In fact, some Hollywood insiders watch box-office receipts between the nomination and the show, to divine who will take home the statuette.) Those millions ripple throughout the film economy: theatres pay tax on ticket sales and concessions; studios pay tax on their own receipts; writers, directors, actors and others with "points" pay tax on back-end profits; and even the kids who serve popcorn and soda pay tax on their meager paychecks.

Oscar nods also boost performers' future paychecks. That means serious tax planning if the lucky winners don't want 35% of the difference winding up in Uncle Sam's pocket. Of course, you don't have to be a movie star to cut your taxes. It just means you need a plan of your own -- one that takes advantage of every legal deduction, credit, loophole, and strategy. We're here to help you star in that plan!

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form. 

Convert Residence To Rental

If you start renting out your former residence, your basis for depreciation purposes is the lower of your adjusted basis at the time of the change or the fair market value (FMV) of the property at that time.

When you sell the property, your basis for figuring a gain is your adjusted basis in the property. On the other hand, the starting basis for computing a loss is the smaller of your adjusted basis or the FMV of the property at the time of the change to business or rental use and then adjusted for depreciation, capital improvements, etc.

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form. 

Vehicle Expense Documentation is Critical

 In Scott P. Lysford et ux. (T.C. Memo. 2012-41) the taxpayer claimed a deduction for his single engine aircraft he flew between his home and a business office some 200 miles distant.

The Court found the taxpayer's records of the trips in his spiral notebooks wholly inadequate. They merely listed the date and destination of airplane and automobile trips. No business purpose for the trips, no names of clients visited, and no description of business scheduled, conducted, or attempted is provided. A list of dates representing the taxpayer's airplane and automobile trips with no identification of the people visited, the locations visited, the nature or purpose of the trips, or the business actually conducted falls well short of the substantiation required by Section 274(d).

For 2006 the taxpayers failed to show that their business use of the airplane exceeded 50%, and the Court sustained the IRS's determination that the $72,210 in airplane overhaul expenses deducted for 2005 under Section 179 relating to the airplane was subject to recapture. For the same reason, the Court sustained the IRS's disallowance of the taxpayer's $39,000 claimed Section 179 current expenses for 2006 relating to the airplane.

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form. 

Without Adequate Records - IRS Can Reconstruct Income

If you don't have adequate books and records, the IRS can reconstruct your income using any of several methods.

In the case of Bradley M. Cohen and Kathy A. Cohen (T.C. Memo. 2003-42) the Court said that when a taxpayer fails to maintain these records, the IRS may determine income under the bank deposits method.

A bank deposit is prima facie evidence of income. The bank deposits method of reconstruction assumes that all money deposited into a taxpayer's account is taxable income, unless the taxpayer can show a nontaxable source for the income. The taxpayer could not produce evidence of a nontaxable source for the deposits made to an S corporation's bank.

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form. 

Federal Taxes Rising Dramatically Next Year!

Most Americans are generally aware that the Bush tax cuts will expire in 2013, and that the new healthcare law will also impose some new taxes. As we get closer to 2013, the scope of the increases will come into clearer focus for taxpayers. For those taxpayers who will be subject to them (generally, married couples with income over $250,000 and singles over $200,000), the new amounts of their income that will be sucked into the abyss of what is the federal budget deficit is eye-popping:

INCOME TYPE	OLD TOP RATE	NEW TOP RATE	% INCREASE
Ordinary income, in general	35%	39.6%	13.14%
Earned income hospital insurance (HI)	1.45%	2.35%	62.06%
Capital gains	15%	23.8%	58.66%
Dividends	15%	43.4%	289.33%
Interest, rents, royalties	35%	43.4%	24%
Estate, Gift & Generation Skipping Transfers	35%	55%	57.14%
Estate, Gift & GST Exemptions	$5.12 million exemption	$1 million exemption	80.46% reduction in exemption

 
The income tax increases arise from two principal components. First, the maximum rates are being rolled back to the pre-Bush tax cut maximums (i.e., 39.6%). Second, investment income for those over the thresholds are subject to an additional 3.8% tax under Obamacare (e.g., on interest, dividends, capital gains, net rental income, and royalties – but excluding tax-exempt municipal bond interest and withdrawals from qualified plans and IRAs). Lastly, the HI tax on earned income is increased by 0.9% on persons over the thresholds.

Note that further increases in taxes will arise in 2013 that are not reflected in the above table. These relate to the return of limits on itemized deductions for higher income taxpayers.

Note that the threshold for the additional 3.8% investment tax and the new 39.6% maximum tax rate is extremely low for estates and noncharitable trusts that do not distribute their investment income (i.e., it is at the same income level that the highest income tax bracket begins to apply). Thus, many of such entities are in for some unpleasant increased check writing to the U.S. Treasury Department come 2013.

Of course, the Bush tax cuts rollback was deferred in 2010 for 2 years, so perhaps this could happen again. Obamacare is also up for review by the U.S. Supreme Court, and there may be a new President or party alignment in Congress after the 2012 elections. So, while all of the above changes will come into law if no new laws are passed, the uncertainty of what will happen in the law that has existed for the last few years will likely persist for the foreseeable future.

NOW! is the time to implament your tax plan so that you do feel the pain of a tax increase.  Call us at 954-591-8290.

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form. 

Reduce Your Taxes and Your Audit Risk

The fear of a tax audit can make people do funny things. 

I've seen people give up thousands in legal tax savings in an effort to hopefully avoid the possibility of an audit, and many times at the advice of their own tax advisor. 

I regularly have clients tell me their prior tax advisor told them not to take a particular deduction because the deduction wasn't worth the audit risk.

Then there's the other side who take deductions they are unsure of and hope they don't get audited. 

When it comes to audit risk, there are two factors to consider: 

First, there's the risk of being audited. There are elements of this risk that can be controlled through proper tax planning and tax return preparation. There are also elements that cannot be controlled. 

Second, if you are audited, there's the risk that adjustments will be made resulting in increased taxes, plus penalties and interest. Proper tax planning and tax return preparation can provide you with tremendous control over this factor. 

When done right, identifying legal tax saving opportunities actually helps reduce your audit risk. 

Here's how.

#1 Following the Tax Rules

The majority of the tax law is intended to reduce your taxes, not increase it. If you follow the rules, you'll enjoy legal tax deductions and be well-prepared for an audit. 

The challenge most people have with this is they don't know the rules and have no interest in reading the tax law to learn them. 

This is why you need a great tax advisor on your team. 

Leverage your tax advisor's knowledge to open a whole new world to what is legally deductible. Understanding exactly what you need to do to legally claim your deductions means that even if you are audited, you have followed the rules and minimized the likelihood of having any audit adjustments. 

For example, if my client has a home office, we go through the home office rules. By making sure the rules are followed, I'm not only making sure my client qualifies for the deduction, but that they know how to document the deduction.

#2 Keeping Proper Documentation

The better your documentation, the greater your tax savings. 

And, the better your documentation, the more prepared you are for an audit. 

Most people hate this step because it's tedious and boring. But, which would you prefer: a little work now to get your documentation in place or having to do it later while an auditor is waiting for it (when it's much more difficult to remember and find it)? 

When you are able to quickly provide an auditor with the documentation they request, the audit usually wraps up quickly.

Reduce Your Taxes, Reduce Your Audit Risk

When I work with clients to create and implement a tax strategy, the result is legally reducing their taxes, but the process includes several steps that actually help them reduce their audit risk at the same time.

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form.