Income Tax Planning for 2015 and Beyond

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1 Income Tax Planning for 2015 and Beyond Presented by: Michael A. Fritton, CPA 3925 River Crossing Pkwy, Suite 300 Indianapolis, IN / somersetcpas.com

2 AGENDA Where we are and where are we going Individual Tax Rates Capital Gains & Dividends Tax Rates Obamacare and Additional Taxes Estate and Gift Taxes Depreciation Like-Kind Exchanges Other Issues Presidential Candidate Tax Platforms

3 Individual Tax Rates Where we are: American Taxpayer Relief Act of 2012 ( ATRA ) makes permanent, for 2013 and beyond, the lower Bush-era income tax rates for all, except for taxpayers with taxable income above: $457,600 for married taxpayers $432,200 for heads of households $406,750 for single taxpayers $228,800 for married filing separately Income above these levels will be taxed at a 39.6% rate (adjusted for inflation)

4 Individual Tax Rates

5 Individual Tax Rates

6 Individual Tax Rates Where are we going? Bush-era tax rates were subject to sunset provisions and reverted to old structure without legislative action Current rate structure is permanent and requires legislative action to change Discussions of tax simplification usually involve lower marginal tax rates coupled with fewer deductions No major changes likely until after 2016 elections

7 Where we are: Capital Gains/Dividend Tax Rates ATRA raised the top rate from 15% to 20% Applies to the extent that a taxpayer s income exceeds the thresholds set for the 39.6% rate Capital Gains and Qualified Dividends are not taxed if you are in the 10% & 15% income tax brackets Gain on sale of real estate related to prior depreciation subject to maximum rate of 25%

8 Where are we going? Capital Gains/Dividend Tax Rates Current rate structure is permanent Capital gains and dividends rate are frequent targets for tax revenue Buffett Tax Carried Interests Rates may increase, but will still likely receive favorable treatment compared to ordinary income No major changes likely until after 2016 elections

9 Obamacare and Additional Taxes Where we are: Affordable Care Act Individual Mandate Penalty? Tax? Shared Responsibility Payment 2014: $95 per adult 2015: $325 per adult 2016: $695 per adult Broad exemptions / Limited collections

10 Obamacare and Additional Taxes Affordable Care Act Employer Mandate Employer Shared Responsibility Delayed until 2015 (and 2016) Gradual phase-in for mid-size employers

11 Obamacare and Additional Taxes New Taxes effective in 2013: 0.9% Medicare Tax on earned income Modified AGI over a threshold amount: Married filing jointly $250k Qualifying widow(er) with dependent child $250k Head of household (with qualifying person) $200k Married filing separate $125k Single Individuals $200k

12 Obamacare and Additional Taxes Section 1411 Net Investment Income Tax Effective January 1, 2013, a new 3.8% tax is imposed on individuals, trusts and estates on the lesser of: Net Investment Income (or undistributed NII in the case of a Trust or Estate), or Modified AGI over a threshold amount: Married filing jointly $250k Qualifying widow(er) with dependent child $250k Head of household (with qualifying person) $200k Married filing separate $125k Single Individuals $200k

13 Obamacare and Additional Taxes Net investment income includes: Interest Income Dividend Income Royalties Annuities Rents (net of allowable expenses) For purposes of the new Medicare & NII tax, this does not include rental real estate if the taxpayer is a real estate professional under PAL rules

14 Obamacare and Additional Taxes Net investment income includes: Gain from disposing of property from a passive activity Income earned from a trade or business that is a passive activity Net investment income does NOT include distributions from qualified retirement plans

15 Obamacare and Additional Taxes Passive vs. Non-Passive Income / Loss Any rental activity is a passive activity There are special rules for real estate rental activities and real estate professionals Material participation in an activity requires that a taxpayer is involved in the operations of the activity on a regular, continuous and substantial basis

16 Obamacare and Additional Taxes Phase out of itemized deductions ATRA officially revives the Pease limitation on itemized deductions However, higher applicable threshold levels apply under the new law $300,000 for married couples and surviving spouses; $275,000 for heads of households; $250,000 for unmarried taxpayers; and $150,000 for married taxpayers filing separately For every $100 of income above threshold, you lose $3 of itemized deductions

17 Obamacare and Additional Taxes Phase out of personal exemptions ATRA also officially revives the personal exemption phaseout rules, but at applicable income threshold levels slightly higher than in the past: Same as Pease Limitation Exemptions are reduced by 2% for each $2,500 ($1,250 for married filing separately) by which the taxpayer s AGI exceeds threshold

18 Obamacare and Additional Taxes Where are we going? Obamacare not going anywhere (Maybe) Pending Supreme Court decisions? Mandates continue to be delayed Waivers continue to be granted Enforcement and collection of Shared Responsibility Payments are questionable Additional hidden taxes are a way to raise taxes without raising tax rates

19 Summary of Top Marginal Tax Rates Ordinary Income Maximum Ordinary Income Tax Rate: 39.6% Net Investment Income Tax: 3.8% Phase out itemized deductions: 1.12% Indiana State Income Tax: 3.4% Marion County Income Tax: 1.77% Total: 49.69%

20 Summary of Top Marginal Tax Rates Dividends / Capital Gains Maximum LTCG Income Tax Rate: 20% Net Investment Income Tax: 3.8% Phase out itemized deductions: 1.12% Indiana State Income Tax: 3.4% Marion County Income Tax: 1.77% Total: 30.09%

21 Summary of Top Marginal Tax Rates Real Estate Capital Gains Maximum 1250 Gain Tax Rate: 25% Net Investment Income Tax: 3.8% Phase out itemized deductions: 1.12% Indiana State Income Tax: 3.4% Marion County Income Tax: 1.77% Total: 35.09%

22 Estate & Gift Taxes Where we are: ATRA permanently provides for a maximum federal estate tax rate of 40% with an annually inflation-adjusted $5 million exclusion for estates of decedents dying after December 31, 2012 Same rate and exclusion for gifts As adjusted for inflation, the exemption is $5,430,000 in 2015.

23 Estate & Gift Tax Portability Election (IMPORTANT!) allows the estate of decedent who is survived by a spouse to apply the decedent s unused exclusion amount to the surviving spouse s own estate transfers during life and at death ATRA makes permanent portability between spouses. In essence, for 2015 a family could transfer assets tax-free up to $10,860,000

24 Estate & Gift Tax The annual gift tax exclusion is $14,000 for 2015 There is no limit on the number of individual donees to whom gifts may be made under the $14,000 exclusion Spouses may "split" their gifts to each donee, effectively raising the per donee annual maximum exclusion to $28,000 Spouses may give an unlimited amount of gifts to one another without any gift tax imposed

25 Estate & Gift Tax Where are we going? The Obama Administration would like to set the top tax rate at 45% and change the applicable exclusion amount for estate taxes to $3.5 million and $1 million for gift taxes These amounts would not be indexed for inflation Push to eliminate minority-interest valuation discounts No major changes likely for near future

26 Depreciation Where we are: Depreciation method and life depends on the type of asset and type of business Section 179: $25,000 expensed in first year Bonus depreciation has expired Real estate: Residential property: 27.5 year life Non-residential property: 39 year life Qualified LHI: 15 years

27 Depreciation Where are we going?: Senate Finance Committee report Proposes four asset pools Eliminates specific asset tracking All real estate depreciated over 43 years. Section 179: $1,000,000 limit Repeal of Like-Kind Exchanges (Yikes!) Sweeping changes are not likely, but individual aspects could be adopted

28 Like-Kind Exchanges Where we are: 1031 Exchange No gain/loss recognized by a taxpayer exchanging qualifying property for like-kind property Qualifying property is property held for productive use in a trade or business or for investment

29 Like-Kind Exchanges Examples of like-kind real property Single-family rental houses Rental condominiums Apartment buildings Retail shopping centers Warehouses Office buildings Unimproved land

30 Like-Kind Exchanges Excluded property includes inventory, stocks/bonds/securities, partnership interests, certificates of trusts or beneficial interests, chooses in action and property outside U.S. Timelines 45 day identification period 180 day replacement period NO exceptions!

31 Like-Kind Exchanges Reasons to Exchange Postpone the recognition of gain indefinitely (or permanently in the case of death) Change the type of investment return that a client currently is receiving from his investment realty portfolio (land for office building) Convert tax attributes of the relinquished property to different tax attributes in the replacement property (capital loss to ordinary loss; non-passive capital gain to passive capital gain)

32 Like-Kind Exchanges Reasons NOT to Exchange Loss would be recognized upon sale Availability to utilize suspended passive losses Availability of low capital gains rates Combination of low capital gains rates and installment sale reporting

33 Like-Kind Exchanges Taxpayer Property B Property B Seller Property A Qualified Intermed. Cash Property A Cash Buyer

34 Like-Kind Exchanges Where are we going? Recent rulings have increased flexibility Reverse Exchanges Related Party Exchanges Tenant-in-Common Interests Senate Finance Committee Report Would Repeal 1031 Effectively retained for non-real property Unlikely to pass

35 Like-Kind Exchanges 1031 Planning Partnerships Going into Coming out of Investor vs. Dealer Original intent Change of intent Tax reporting Timing!!!!

36 Other Issues Retirement planning tips Foreclosure issues Repair and Capitalization Regulations Cost Segregation

37 Retirement Planning Tips Retirement Plan & Health Savings Plan Contribution Limits for k $18,000 plus $6,000 catch up Simple - $12,500 plus $3,000 catch up SEP - $53,000 IRA - $5,500 plus $1,000 catch up HSA - $3,350 / $6,650 plus $1,000 catch up Flex Spending Accounts $2,550

38 Retirement Planning Tips Other Tips Are you maxing out your deferrals? Are you maxing out free money from employer matching? Roth vs. Traditional? Change allocations as you age Use H.S.A. accounts as supplemental retirement accounts if already maxing out other options

39 Foreclosure Issues Voluntary Conveyance, Foreclosure, Deed in Lieu of Foreclosure.giving it back: Nonrecourse: Treated as a deemed sale in which the loan balance is considered sales proceeds. Therefore taxable capital gain when loan balance exceeds the tax cost/basis in property

40 Foreclosure Issues Voluntary Conveyance, Foreclosure, Deed in Lieu of Foreclosure.giving it back: Recourse: Different than nonrecourse in that the taxable capital gain recognized is the Fair Market Value (FMV) over the tax cost/basis. Also may need to recognize Cancellation of Debt (COD) income when the debt exceeds the FMV. COD income is ordinary income subject to ordinary income tax rates

41 Foreclosure Issues Voluntary Conveyance, Foreclosure, Deed in Lieu of Foreclosure.giving it back: Nonrecourse example: Debt discharged = $21,500,000 Less tax basis = $16,500,000 Capital Gain = $ 5,000,000

42 Foreclosure Issues Voluntary Conveyance, Foreclosure, Deed in Lieu of Foreclosure.giving it back: Recourse example: Fair Market Value = $17,000,000 Less Tax Basis = $16,500,000 Capital Gain = $ 500,000 Debt Discharged = $21,500,000 Less Fair Market Value = $17,000,000 COD Income (ordinary) = $ 4,500,000

43 Foreclosure Issues COD Income Exclusions Bankruptcy Insolvency Qualified Real Estate Indebtedness Qualified Farm Indebtedness Reductions in Tax Attributes Reductions in Basis

44 Repair and Capitalization Regulations Outline policies and procedures for expensing and capitalizing items. De Minimis Exceptions Existing Unit of Property Apply tests to building subsystems Betterment Test Adaptation Test Restoration Test Major Component Substantial Structural Part Catch-Up Provisions

45 Cost Segregation Principle goal: increase cash flow from constructed buildings, purchased properties and renovations by accelerating depreciation expense deductions Components of a building are reclassified into proper class lives according to government legislation, case law and IRS revenue rulings/procedures

46 Cost Segregation Substantial tax savings can be achieved by accelerating depreciation deductions thus increasing cash flow Identifies building costs and land improvements that would be depreciated over 27.5 or 39 years into asset classes with shorter depreciable lives (5, 7 or 15 years) Accelerates depreciation does not increase depreciation

47 Cost Segregation Which properties are candidates for a Cost Seg Study? New construction New renovations Recently purchased

48 Cost Segregation If Cost Seg Study not done in previous years, clients may have a Cost Seg Study performed now Not only for open years!! Able to go back to closed years Need to file Form 3115, Change in Accounting Method (automatic consent) in current tax year Adjustment is a catch up deduction in current tax year

49 Cost Segregation Benefits/Advantages: Accelerated depreciation deductions (front loading) Reduced tax liability Increase in cash flow Building components needing replaced can be written off since specifically identified

50 Cost Segregation Concerns/Disadvantages: Cost Depreciation Recapture if selling soon after construction or purchase Personal Property Tax Taxable Income/Marginal Tax Rates consideration

51 Presidential Candidate Tax Platforms Republican Candidates Marco Rubio Jeb Bush Chris Christie Rand Paul Ted Cruz Ben Carson Mike Huckabee Scott Walker

52 Presidential Candidate Tax Platforms Marco Rubio Most detailed plan 2 Individual brackets (15%/35%) Eliminate most deductions Personal and child credits 25% corporate tax rate Fully deduct capital improvements Eliminate double taxation Eliminate special business credits and deductions

53 Presidential Candidate Tax Platforms Jeb Bush Generally follows Bush 41 and 43 Eliminated Florida Intangibles Tax Reduced property and business taxes Chris Christie Lower rates across the board 3 individual brackets (25% top rate) Eliminate special exemptions and deductions Retain mortgage interest and charitable deductions 25% top corporate rate

54 Presidential Candidate Tax Platforms Rand Paul 17% Flat Tax Eliminate most tax breaks Eliminate tax on investment income Balanced budget amendment Ted Cruz Abolish IRS Advocated Flat Tax Postcard return

55 Presidential Candidate Tax Platforms Ben Carson 23% Consumption Tax (Fair Tax / VAT) Mike Huckabee 30% Consumption Tax (Fair Tax / VAT) Scott Walker Supply Side reform Lower rates / reduce spending

56 Presidential Candidate Tax Platforms Democratic Candidates Hillary Clinton Martin O Malley Bernie Sanders

57 Presidential Candidate Tax Platforms Hillary Clinton Return to WJC policies No increase for those under $250K Advocated repeal of Bush tax cuts for wealthy Eliminate oil and gas subsidies Require contributions to alternative energy fund Eliminate deferral of overseas income Increase scrutiny of CEO salaries

58 Presidential Candidate Tax Platforms Martin O Malley Progressive tax policy Increase tax on top 15% Reduce tax on bottom 85% Bernie Sanders Self-described Socialist Progressive estate tax to reduce wealth inequality 10% billionaire surtax Higher rates on investment income Tax foreign income of U.S. corporations

59 Today s speaker: Michael A. Fritton, CPA Contact Information Principal--Real Estate Team mfritton@somersetcpas.com Somerset CPAs, P.C River Crossing Pkwy, Suite 300 Indianapolis, IN / info@somersetcpas.com somersetcpas.com