Individual & Business Tax Planning Update

Transcription

1 Individual & Business Tax Planning Update November 14, 2013 HMWC CPAs & Business Advisors Presented by: Curtis Campbell Janet Anderson Joel Jorrisch DID YOU KNOW? 2 1

2 2013 MARKS THE 100 TH ANNIVERSARY OF THE U.S. INCOME TAX RETURN 3 TRIVIA QUESTION: WHAT WERE THE TAX RATES BACK IN 1913? 4 2

3 The 1913 tax rates were 1% 2% 3% 4% 5% 6% over $20,000 - $50,000 over $50,000 - $75,000 over $75,000 - $100,000 over $100,000 - $250,000 over $250,000 - $500,000 over $500,000 5 The agenda Washington Report Tax Planning for Individuals Tax Planning for Businesses 6 3

4 WASHINGTON REPORT What s New? 2013 Major Legislation Highlights American Taxpayer Relief Act (ATRA) Affordable Care Act provisions (ACA) Defense of Marriage Act (DOMA) struck down Final Regs for Repairs and Capitalization CA new EZ credits regime CA Prop 39 single sales method for apportionment CA reinstatement of Qualified Small Business Stock benefits for 2008 to

5 ATRA Highlights Increase in top earned income rates Increase in combined top LT Capital gain and dividend rates Revived Pease limitations on itemized deductions and personal exemption phase out for high income taxpayers Code Section 179 Expensing Limit of $500,000 expires after 2013 (unless extended) 50% Bonus Depreciation expires after 2013 (unless extended) 9 Recent Tax Increases Under Patient Protection and Affordable Care Act, Proposition 30 and American Taxpayer Relief Act Combined Top Earned Income Rates Year Federal Base Medicare California Total Increase % None 13.3% 48.3% +3.0% % 0.9% 13.3% 53.8% +5.5% Combined Top LT Capital Gain & Dividend Rates Year Federal Base Medicare Surtax California Total Increase % None 13.3% 28.3% +3.0% % 3.8% 13.3% 37.1% +8.8% 10 American Tax Payer Relief Act of 2012 (over $400k and MFJ over $450k) Obamacare (over $200k or MFJ $250k) California Proposition 30 (over $500k or MFJ over $1 million) 5

6 ACA Highlights 3.8% Medicare Surtax on Unearned Income 0.9% Hospital Insurance Tax on Earned Income Maximum Salary Reduction Under FSA is $2,500 (Just passed new $500 carryover provision effective for 2013) Threshold for medical expense itemized deduction is raised from 7.5% to 10% of AGI For 2014, Individuals, unless exempt, must obtain minimum essential coverage or be subject to penalties ( Individual Mandate ) Employers with 50 or more employees will pay an assessment if employees are not offered minimum essential coverage (Delayed until 2015) 11 Summary of Final Regs on Repairs and Capitalization Revised and simplified de minimis safe harbor for purchase of materials and supplies. Safe Harbor for routine maintenance to tangible property. Annual election for certain buildings to deduct up to $10,000 of maintenance costs. A new annual election to capitalize repair costs that are capitalized on a taxpayer s books and records. Refinement of the criteria for defining betterments and restorations to tangible property. Final regs effective beginning January 1, 2014 (can apply retroactively to the start of 2012 i.e. amend those returns). 12 6

7 EZ and Other credits End This Year Beginning January 1, 2014, the Legislature has eliminated designated economic development areas, such as Enterprise Zones (EZs). The pre existing EZs are being replaced by a more restrictive regime. The definition of who qualifies for the hiring credit is no longer someone who lives and works in an EZ. BUT, there is still time to take the hiring credit in 2013 based on the old rules. 13 New California Propositions Proposition 39 o Eliminates ability of multistate businesses to choose how taxable income is allocated to California. Under this measure, starting in 2013, multistate businesses are no longer allowed to use the 3 Factor Formula for allocating income. Instead, most multistate businesses will have to determine their California taxable income using the single sales factor method. Businesses that operate only in California would be unaffected by this measure. 14 7

8 Small Business Stock Benefits Gone After 2012 Relief for AB 1412 In the wake of the Cutler decision, the Legislature passed AB 1412 and SB 209. This means that for taxable years 2008 through 2012, taxpayers may exclude 50% of the gain on the sale of qualified small business stock. AB 1412 fully reenacts the 50% exclusion/deferral of gain when selling qualified small business stock (QSBS) for taxable years 2008 through The bill also modifies the California property and payroll requirements, which were deemed unconstitutional in Cutler. Returns can be amended Other Legislation Highlights Revenue Procedure Simplified Safe Harbor Method for Claiming Home Office Deduction Revenue Procedure Simplified Method for Requesting Late S Corp election TC Memo Tax Court finds S Corp shareholders not entitled to basis for guaranteed amounts. Sun Capital Partners III, LP vs. New England Teamsters & Trucking Industry Pension Fund (Carried Interest) 16 8

9 Facts on Income Tax Burden Statistics (2010 Tax Year) Top 1% of filers paid 37.4% of all Federal income taxes o AGI of at least $369,691 Top 5% of filers paid 59.1% of total Federal income taxes o AGI of at least $161,579 Top 10% of filers paid 70.6% of total tax burden o AGI of at least $116,623 Bottom 50% of filers pay 2.36% of total Federal tax bill, mainly due to credits. 17 Data from taxpolicycenter.org and taxfoundation.org INDIVIDUAL TAX PLANNING Should tax law changes affect your planning this year? 9

10 Timing income and expenses Smart timing can reduce your tax liability poor timing can unnecessarily increase it If you don t expect to be subject to the AMT in 2013 or 2014: o Deferring income to 2014 and accelerating deductible expenses in 2013 typically is a good idea because it will defer tax If you expect to be in a higher tax bracket in 2014 or if you expect tax rates to go up: o The opposite approach may be beneficial Accelerating income will allow more income to be taxed at your current year s lower rate Deferring expenses will make deductions more valuable 19 What you may be able to time Income items o Bonuses o Consulting or other self-employment income o U.S. Treasury bill income o Retirement plan distributions, to the extent not required Deductible expenses o State and local income taxes o Property taxes o Mortgage interest and margin interest o Charitable contributions 20 10

11 21 AGI-based reduction on itemized deductions returns for 2013 AGI thresholds for triggering the reduction are: o $250,000 for singles o $275,000 for heads of households o $300,000 for married filing jointly o $150,000 for married filing separately Reduces otherwise allowable deductions by 3% of amount by which AGI exceeds applicable threshold Doesn t apply to deductions for medical expenses, investment interest, or casualty, theft or wagering losses AGI-reduction strategies may allow you to stay under the threshold If you ll be subject to the reduction, consider its impact before timing deductible expenses AGI $ 670,000 $ 670,000 Threshold (300,000) AGI > Threshold 370,000 x 3% Potential Reduction $ 11,100 * Itemized Deductions 90,000 90,000 x 80% Potential Reduction $ 72,000 * Itemized Deductions 90,000 90,000 Reduction (*Lesser) - (11,100) $ 90,000 $ 78,900 Lost Benefit 0% 12% 11

12 Personal exemption phaseout also returns 23 Kicks in at same AGI thresholds as the itemized deduction reduction: o $250,000 for singles o $275,000 for heads of households o $300,000 for married filing jointly o $150,000 for married filing separately Reduces exemptions by 2% for each $2,500 (or portion thereof) by which a taxpayer s AGI exceeds the applicable threshold o 2% of each $1,250 for married taxpayers filing separately AGI-reduction strategies may allow you to stay under the threshold Exemptions for 2013 is $3, % Medicare Surtax on Unearned Income Tax imposed on the lesser of o Net Investment Income, or o The excess of Modified AGI over $200,000 for single filers or $250,000 for married filing joint What is Net Investment Income (NII)? o Interest, dividends, royalties, rents, gains from dispositions of property from a passive activity and income from a trade or business that is a passive activity o Does not include interest on tax exempt bonds, veterans benefits, the excluded portion of the gain on the sale of a principal residence, or distributions from qualified plans or IRAs

13 .9% Hospital Insurance Tax on Earned Income Tax imposed on earned income in excess of $200,000 for a single taxpayer and $250,000 for married filing joint. 25 Rob & Rita Retired Taxable Interest & Dividends $200,000 Social Security 20,000 IRA Distribution 200,000 Modified AGI $420,000 Less Threshold (250,000) Excess $170,000 Net Investment Income $200,000 Lesser of NII or Excess $170, % Medicare Surtax $ 6,460 $125,000 20, ,000 $345,000 (250,000) $ 95,000 $125,000 $ 95,000 $ 3,610 What if $75,000 of interest income came from municipal bonds? 26 13

14 Rick & Ruth Real Estate Owners Wages $200,000 Taxable Interest & Dividends 55,000 Passive Activities 165,000 Modified AGI $420,000 Less Threshold (250,000) Excess $170,000 Net Investment Income $220,000 Lesser of NII or Excess $170, % Medicare Surtax $ 6,460 $200,000 55, ,000 $420,000 (250,000) $170,000 $ 55,000 $ 55,000 $ 2,090 What about real estate professionals? 27 Sam & Susan S Corp Owners Wages from S Corp $400,000 Interest 10,000 Flow-thru from S Corp 10,000 Modified AGI $420,000 Less Threshold (250,000) Excess $170,000 Net Investment Income $ 10,000 Lesser of NII or Excess $ 10, % Medicare Surtax $ 380.9% Hospital Insurance Tax $400, ,000 = $150,000 $150,000 x $ 1,350 $225,000 10, ,000 $420,000 (250,000) $170,000 $ 10,000 $ 10,000 $ 380 $ 0 28 What if wages are $225,000 and the income flowing thru from S Corp is $185,000? 14

15 Other Strategies! Minimize 3.8% Medicare Surtax o Sell assets with unrealized loss o Invest in Tax Exempt securities o Consider Roth conversions o Maximize retirement contributions o Direct charitable contribution from IRA 29 Increase in top capital gains rate Top 20% long-term rate returns in 2013 Kicks in when taxable income exceeds: o $400,000 for singles o $425,000 for heads of households o $450,000 for married filing jointly o $225,000 for married filing separately Most taxpayers subject to 20% long-term capital gain rate will also be subject to the 3.8% NII tax total of 23.8% Taxpayers with taxable income below the thresholds still enjoy the 15% rate Qualified dividends are taxed like long-term capital gains 30 15

16 Small business stock Enjoy preferential tax treatment o Convert capital losses to ordinary losses o Defer tax on gain o Exclude up to 50% of gain (must hold the stock for at least five years) o Depending on acquisition date, exclusion may be 75% or 100% TIP: To be a QSB, the business must be engaged in an active trade or business and not have assets that exceed $50 million Restricted stock Ordinary vs. Capital Income recognition normally deferred until stock is no longer subject to risk of forfeiture or you sell it o You pay tax at your ordinary-income rate on stock s FMV when restriction lapses Make Sec. 83(b) election to recognize ordinary income when you receive stock o Allows you to convert future appreciation from ordinary income to long-term capital gains income, which may be beneficial if: The income is often negligible The stock is likely to appreciate significantly before income would otherwise be recognized o Downsides: You must prepay tax in the current year and you could trigger or increase exposure to the 39.6% ordinary-income tax rate or the 0.9% Medicare tax These taxes can t be refunded if you eventually forfeit the stock or sell it at a decreased value 16

17 Home-related deductions Property tax deduction o Pay tax when it s most beneficial o Isn t deductible for AMT purposes Mortgage interest deduction o Up to combined total of $1 million of mortgage debt o Deduct points paid related to principal residence Home equity debt interest deduction o Debt limit of $100,000 on debt used for any purpose o Consider using home equity debt to pay off credit cards or auto loans 33 Home sales When selling principal residence, you can exclude up to $250,000 ($500,000 for joint filers) of gain o To support tax basis, keep thorough records o You must meet certain tests, and gain that s allocable to a period of nonqualified use generally isn t excludable Gain qualifying for exclusion will also be excluded from new 3.8% Medicare contribution tax Losses on principal residence generally aren t deductible Second homes are ineligible for gain exclusion o Consider converting to rental use before selling o Defer tax on gains via an installment sale or Section 1031 exchange 34 17

18 Exclusion for Home Mortgage Debt Discharge Gross income includes cancellation of debt unless an exclusion applies For 2013 Taxpayers can exclude up to $2 million of income from the discharge of qualified principal residence indebtedness. 35 Federal Fair Market Value $ 500,000 Mortgage Debt (Recourse) 650,000 Cancellation of Debt 150,000 Exclusion (150,000) Cancellation of Debt Income $ - Fair Market Value 500,000 Basis 300,000 Gain on Sale $ 200,000 Real estate activity rules Income and losses are typically passive o Passive income may be subject to 3.8% Medicare tax o Passive losses are deductible only against passive income; excess is carried forward Real estate professionals qualify for active tax treatment o Perform more than 50% of personal services in real property trades or businesses and meet material participation requirements o Spend more than 750 hours of service in such businesses Increase hours to meet the test Special rules for spouses may also help WARNING: Each year stands on its own, and there are other nuances to be aware of

19 Tax-deferral strategies for investment property Divest yourself of appreciated investment real estate and defer the tax liability o May enable you to keep income low enough to avoid: 3.8% Medicare contribution tax on net investment income 20% long-term capital gains rate Installment sale o Defer gains by spreading over several years as you receive the proceeds o Ordinary gain is recognized in year of sale, even if no cash is received Section 1031 exchange o Allows you to defer paying tax on gain until you sell replacement property o Restrictions and significant risks apply 37 Saving for Retirement Employer-sponsored plans, such as 401(k)s, 403(b)s, 457s, and SIMPLEs o Pretax contributions reduce taxable income o Plan assets grow tax-deferred o Possible pretax employer matching Traditional IRAs o Contributions may be deductible o Assets grow tax-deferred o 2013 contributions can be made as late as April 15, 2014 Roth IRA o Limitation applies 38 19

20 How much can you contribute in 2013? 39 Cash donations Easy to make; the key is to substantiate them o Under $250: gift supported by canceled check, credit card receipt or written communication from charity o $250 or over: gift must be substantiated by the charity Deduction limits o Can t exceed 50% of AGI (30% for gifts to non-operating private foundations) o Excess can be carried forward up to five years 40 20

21 Stock donations Publicly traded stock held more than one year can be one of the best charitable gifts o Can deduct current fair market value o Avoid tax on gain from selling the property o Especially beneficial if you face the new 3.8% Medicare tax on investment income or the return of the top 20% long-term capital gains rate this year Deduction limits o Can t exceed 30% of AGI (20% for non-operating private foundations) o Excess can be carried forward up to five years WARNING: Don t donate stock worth less than your basis. Instead, sell it so you can deduct the loss. Then donate the proceeds. 41 Charitable remainder trusts Enjoy income from a CRT o Benefits a charity while ensuring your financial future o For a given term, it pays an amount to you (some of which may be taxable) o At term s end, remaining assets pass to one or more charities o You receive a deduction for the present value of amount going to charity o Property is removed from your estate o Can help diversify your portfolio if you own non-income-producing assets that would generate a large capital gain if sold 42 21

22 Educational Credits, Deductions and Savings Credits o American Opportunity Credit o Lifetime Learning Credit Deductions o Tuition and Fees o Student Loan Interest 529 Prepaid Tuition Plans o Contributions not tax deductible o Earnings accumulate tax free o Distributions for qualified expense are tax free 43 Jumpstarting a 529 plan To avoid gift taxes on ESA and 529 plan contributions, you must apply your gift tax annual exclusion or lifetime exemption A special break just for 529 plans allows you to front-load five years worth of annual exclusion gifts in one year o This adds up to $70,000 $140,000 if you and your spouse split the gift o This is per beneficiary For grandparents, this can be a powerful estate planning strategy o Can significantly reduce the size of their taxable estates while preserving their lifetime exemptions o Avoids the generation-skipping transfer tax without using up any of their GST tax exemption 44 22

23 Foreign Reporting Do you have a bank account or securities account in a foreign country? Are you a signer on a foreign account? Do you own any foreign assets? (Stocks or real estate) PLEASE TELL US 45 BUSINESS TAX PLANNING A mix of good and bad tax news requires careful planning 23

24 Cash or Accrual? Method of Accounting Is Key! 47 Cash Basis Taxpayers Tax Planning Strategies Delay Billing to Delay Receipt Beware of Constructive Receipt Prepay Expenses Credit Card Charges Count! 48 24

25 Accrual Basis Taxpayers Tax Planning Begins with the Balance Sheet Write off Bad Accounts Receivable Write off Obsolete Inventory (WIP) Review Accruals Fixed Assets vs. Repairs 49 Understanding depreciation MACRS o Generally more advantageous than straight-line method o Larger deduction in early years of asset s life Bonus depreciation o 50% bonus depreciation for assets placed in service from Jan. 1, 2013, through Dec. 31, 2013 o Qualified assets include any new tangible property with a recovery period of 20 years or less No bonus depreciation after Dec. 31,

26 Sec. 179 expensing election Allows you to deduct rather than depreciate asset purchases New or used assets qualify, such as: o Equipment o Furniture o Off-the-shelf computer software ATRA extended higher expensing limit of $500,000 through 2013 o Phases out dollar-for-dollar when 2013 asset purchases exceed $2 million o Can t reduce net income below zero to create a net operating loss WARNING: Sec. 179 expensing limit and phaseout threshold are scheduled to drop to $25,000 and $200,000, respectively, in Cost segregation study Identifies property components and related costs that can be depreciated faster Increases your current deductions Qualifying assets include o Decorative fixtures o Security equipment o Parking lots o Landscaping o Architectural fees allocated to qualifying property Long term strategy 52 26

27 Employing your children Business owners can hire their kids and deduct their pay o Children can earn $6,100 in 2013 and pay zero federal income tax o Children can earn an additional $5,500 without paying tax if they contribute it to a traditional IRA TIP: Children must perform actual work and be paid in line with what you d pay nonfamily employees. 53 Vehicle-related tax breaks Deduct actual out-of-pocket expenses (fuel, insurance, depreciation, etc.) or mileage o 56.5 cents per business mile driven in 2013 Purchases of new or used vehicles may be eligible for Sec. 179 expensing New vehicles may be eligible for bonus depreciation Passenger automobiles are subject to lower limits If a vehicle is used for both business and personal purposes, the associated expenses must be allocated between deductible and nondeductible use Many additional rules and limits apply 54 27

28 Manufacturers deduction Deductible amount is 9% of the lesser of qualified production activities income or taxable income, limited by W-2 wages paid Available also to businesses engaged in nonmanufacturing activities, such as o Construction o Engineering o Architecture o Computer software production o Agricultural processing Deduction can be used against the AMT 55 Credits More Valuable than Deductions! Federal and California o Research & Development o Low Income Housing Federal Only o Work Opportunity Credit o Small Employer Health Insurance Credit California Only o Job s Credit o Enterprise Zone Hiring & Sale or Use Tax Credit 56 28

29 57 Options for business owners and the self-employed Profit-Sharing Plan o Defined contribution plan that allows discretionary employer contributions and flexibility in plan design o You can make deductible 2013 contributions as late as the due date of your 2013 return, including extensions Simplified Employee Pension (SEP) o Provides benefits similar to profit-sharing plan but easier to administer o You can establish a SEP in 2014 and still make deductible 2013 contributions as late as the due date of your 2013 return, including extensions Defined Benefit Plan o Sets future pension benefit and sets contributions needed to attain benefit o Employer contributions are generally required o You can make deductible 2013 contributions as late as the due date of your 2013 return, including extensions How Do They Stack Up for 2013? Plan Profit Sharing SEP Defined Benefit Maximum Contribution $51,000 (or $56,500) $51,000 (or $56,500) Actuarially Determined 58 29

30 Foreign IC-DISC: Interest Charge Domestic International Sales Corporation United States Sales Company Commission paid on Foreign Sales IC-DISC Qualified Dividends paid to Shareholders 59 Works best for companies with $2 million or more of qualified foreign sales. One Final Strategy! Captive Insurance Company What is it? How does it work? Pays Premiums Company Provides Insurance Captive Insurance Company 60 Works best for companies with $400,000 or more of excess cash flow. 30

31 Tax Planning One Size Does Not Fit All 61 Thank you for attending HMWC CPAs & Business Advisors Please contact us for assistance: Curtis Campbell Janet Anderson Joel Jorrisch 31