Individual & Business Tax Planning Update November 14, 2012 HMWC CPAs & Business Advisors Presented by: Curtis Campbell Janet Anderson The agenda Washington Report Healthcare Reform Tax Planning 2 1
WASHINGTON REPORT What s Next? Who Won 4 SENATE HOUSE THE NEW 113 TH CONGRESS DEMOCRATS REPUBLICANS INDEPENDENTS OLD NEW OLD NEW OLD NEW 51 53 47 45 2 2 190 199 240 236 0 0 2
If Congress Fails to Act 2012 2013 Individual Tax Rates 10% to 35% 15% to 39.6% Itemized deductions/exemptions No limitations Reinstate phase out Capital lgi Gains 0% / 15% 8% / 18% / 20% Dividends 15% Ordinary income rates Top Estate/Gift tax rate/exemption 35%/ $5.12 million 55%/ $1 million Alternative Minimum Tax $33,750 Single / $45,000 MFJ Adjusted for inflation American Opportunity Tax Credit Up to $2,500 Unavailable Code sec. 179 limitation $139,000 $25,000 Bonus Depreciation 50% Unavailable Research Tax Credit Unavailable Unavailable Employee Payroll Tax Holiday 4.2% 6.2% COD for Personal Residence Mtg Available Unavailable Charitable Contribution of IRA Available Not Available 5 Selected Positions of Political Parties Individual Taxes Democrats Republicans 2013 Rates 10% to 39.6% 10% to 35% Capital Gains/Dividends 20% / 39.6% 0% & 15% Medicare Tax 3.8% / 0.9% Eliminate Itemized Deductions Reinstate phase outs Eliminate phase outs. Limit certain itemized deductions AMT Buffet Rule Eliminate AOTC Extend? Muni Bond Interest Taxable for higher income Taxable for higher income Child tax credit Make permanent Make permanent Estate/gift tax 45%/$3.5 million Eliminate 6 3
Selected Positions of Political Parties Corporate Taxes Democrats Republicans 2013 Rates 28% 25% Sec. 179 exp.?? Bonus depreciation Extend 100% through 2012 Discussed extending Research tax credit Make permanent Make permanent Tax Carried interest Yes No Oil & Gas tax benefits Eliminate No change Small business stock exclusion Makepermanent? Foreign taxation Worldwide with reforms Territorial System 7 What Could Happen Now? Congress could PUNT! o Bush tax rates/cuts will be extended Gridlock o Nothing will be done 8 4
What Could Happen Now? Congress could compromise o Individuals o Individuals Higher ordinary income rates Capital gains/dividends taxed at 20% AMT patch reinstated Estate tax - $3.5 million / 45% o Businesses R&D Tax Credit extended Lower overall corporate tax rates Bonus depreciation/sec. 179 expensing increased 9 Facts on Income Tax Burden Statistics (2009 Tax Year) Top 1% of filers paid 36.7% of all Federal income taxes o AGI of at least $343,922 Top 5% of filers paid 58.7% of total Federal income taxes o AGI of at least $154,643 Top 10% of filers paid 70.5% of total tax burden o AGI of at least $112,124 Bottom 50% of filers pay 2.25% of total Federal tax bill, mainly due to credits. 10 5
New California Propositions Proposition 30 o A temporary, four-year, 0.25% increase in the state sales and tax beginning on January 1, 2013 and ending on December 31, 2016. o A temporary, seven-year increase in income tax rates for the three highest income brackets (effective from January 1, 2012): Single Married $250k - $300k 10.3% $500k - $600k 10.3% $300k - $500k 11.3% $600 - $1 million 11.3% Greater than $500k - $1 million 12.3% Greater than $1 million* 13.3% Greater than $1 million 13.3% *Includes additional mental health tax rate of 1% 11 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. 12 6
HEALTHCARE REFORM GOOD MEDICINE OR BITTER PILL? Individual Responsibilities for Health Coverage Coverage and Reporting Requirements for Employers Revenue Raisers In 2010 HealthCare Reform Timeline New Business Tax Credit for Purchasing Group Health Coverage Through 2013 Available for employers with 10 or fewer FTEs, who earn less than $25,000 per year Partial credits available to businesses with fewer than 25 FTEs, who earn less than $50,000 Maximum credit is 35% of premiums paid by employer Employer must contribute at least 50% of total premium Coverage for Children Until Age 26 10% Tax on Indoor Tanning Services 14 7
HealthCare Reform Timeline In 2011 Employers Required to Disclose Value of Healthcare Benefits on Employee W-2 Delayed to 2012 W-2s Expense reimbursements for medications from FSA, HSA, MSA and medical expense reimbursement plans limited to prescribed drugs or insulin 15 HealthCare Reform Timeline Starting in 2013 Revenue Raisers! Maximum Salary Reduction Under FSA Plan is $2,500 Threshold for medical expense itemized deduction is raised from 7.5% to 10% of adjusted gross income 3.8% Medicare Tax on Unearned Income.9% Hospital Insurance Tax on Earned Income 16 8
Healthcare Reform Timeline 2014 and Beyond Individuals, unless exempt, must obtain minimum essential coverage or be subject to penalties Employers with 50 or more employees will pay an assessment if employees are not offered minimum essential coverage A nondeductible 40% excise tax will be assessed on the excess benefits of high cost employer sponsored health coverage (Cadillac Plans) 17 3.8% Medicare Surtax on Unearned Income 18 Tax imposed on the lesser of Net Investment Income, or The excess of Modified AGI over $200,000 for single filers or $250,000 for married filing joint What is Net Investment Income? Interest, dividends, royalties, rents, gains from dispositions of property p from a passive activity and income from a trade or business that is a passive activity 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. 9
.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 a single taxpayer and $250,000 for married filing joint. 19 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 NIT or Excess $170,000 3.8% Medicare Surtax $ 6,460 $125,000 20,000 200,000 $345,000 <250,000> $ 95,000 $125,000 $ 95,000 $ 3,610 What if $75,000 of interest income came from municipal bonds? 20 10
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 NIT or Excess $170,000 3.8% Medicare Surtax $ 6,460 $200,000 55,000 165,000 $420,000 <250,000> $170,000 $ 55,000 $ 55,000 $ 2,090 What if the taxpayers qualify for real estate professional treatment and passive activity is a rental property? 21 Sam & Susan S Corp Owners Wages from S Corp $400,000 Interest 10,000 Flow-thru from S Corp 10,000 Modified AGI $420,000000 Less Threshold <250,000> Excess $170,000 Net Investment Income $ 10,000 Lesser of NIT or Excess $ 10,000 3.8% Medicare Surtax $ 380.9% Hospital Insurance Tax $400,000 250,000 = $150,000 $150,000 x 0.009 $ 1,350 $225,000 10,000 185,000 $420,000000 <250,000> $170,000 $ 10,000 $ 10,000 $ 380 $ 0 22 What if wages are $225,000 and the income flowing thru from S Corp is $185,000? 11
Other Strategies! Minimize 3.8% Medicare Surtax Sell appreciated assets in 2012 Declare special dividend in 2012 Consider 2012 Roth conversion Maximize retirement contributions Minimize i i.9% Hospital Insurance Tax Receive bonuses by December 31, 2012 For self-employed individuals, accelerate billings into 2012 23 Employer To Do List Healthcare Reform Adjust withholding to collect extra Medicare tax for higher-wage earners. Flag new limits on salary reductions for health flexible spending accounts. Make sure W-2 reporting includes value of 2012 health coverage (small employers have until 2014 to comply). Provide four-page summary of insurance benefits (plan years beginning on or after September 23, 2012). Inform workers about state health coverage exchange programs (2014). 24 12
INDIVIDUAL TAX PLANNING Rising rates and expiring breaks complicate tax planning Timing of income and expenses is key Smart timing can reduce your tax liability Tax rates are scheduled to rise in 2013 Itemized deductions are scheduled to be limited in 2013 TIP: Consider taking the opposite approach accelerate income? 26 13
Know which items to time On the income side o Bonuses and self-employment income o Consider selling appreciated assets o Retirement plan distributions, if not required On the expense side o State and local income taxes o Property taxes o Mortgage or margin interest o Charitable contributions o Consider selling assets with unrealized losses TIP: Higher-income taxpayers may have an opportunity for some larger deductions through 2012. 27 The 0% rate Through 2012, long-term capital gains rate is 0% for gain that would be taxed at 10% or 15% based on your ordinary-income rate TIP: The 0% rate is scheduled to expire after 2012, so you may want to act soon. 28 14
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. 29 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 Exclusion may be limited Losses on principal residence aren t deductible Second homes are ineligible for gain exclusion o Convert to rental use before selling 30 15
Real estate activity losses Losses are typically passive Real estate professionals can deduct losses fully if annually all they o Perform more than 50% of personal services in real property trades or businesses o Spend more than 750 hours of service in such businesses o Meet material participation requirements o California does not conform TIP: Special rules for spouses may help you meet the 750-hour test. 31 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 32 16
Tax-deferral strategies for investment property 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 TIP: These strategies may be risky until there s more certainty about future capital gains rates. 33 Saving for retirement Employer-sponsored plans o o o o o 401(k)s, 403(b)s, 457s, SARSEPs and SIMPLEs Pretax contributions reduce taxable income Plan assets grow tax-deferred Possible employer matching SIMPLEs require employer contributions Traditional IRAs o o o Contributions may be deductible Plan assets grow tax-deferred 2012 contributions can be made up to April 15, 2013 34 17
How much can you contribute in 2012? 35 IRAs for teens 36 2012 contribution limit o Lesser of $5,000 or 100% of earned income Traditional IRAs o Contributions are deductible o Distributions are taxed Roth IRAs o Contributions aren t deductible o Qualified distributions are tax-free Which is better? o If child earns no more than $5,950 in 2012 and has no unearned income, he or she will pay zero federal income tax o A deduction for a traditional IRA contribution will provide no tax benefit 18
Roth IRAs Qualified distributions are tax-free, but aren t required during your life Contributions don t reduce current-year taxable income Roth conversions o Tax on conversion o Tax-free distributions o Estate planning opportunities o AGI limit it on conversion eliminated i o Back door Roth IRA o Avoids ObamaCare issues (3.8% of AGI) 37 529 plan pluses and minuses PROS: 529s offer higher contribution limits (determined by sponsoring state) No income-based limit for contributing No beneficiary age limit for contributions or distributions You can make tax-free rollovers to another 529 plan every 12 months Under prepaid tuition program, tuition is locked in CONS: Limited to the investment options the plan offers Investment options can be changed only once per year or when beneficiaries change 38 19
Jumpstarting a 529 plan To avoid gift taxes, limit contributions to $13,000 annual exclusion amount or use part of your lifetime gift tax exemption Front-load five years worth of annual exclusion gifts in one year per beneficiary 39 Education credits and deductions American Opportunity credit o Covers 100% of first $2,000 of tuition and related expenses; 25% of next $2,000 of expenses o Maximum credit is $2,500 per year for first four years of college o It may revert to less beneficial Hope credit after 2012, but it may be extended Lifetime Learning credit o Up to $2,000 per tax return for college expenses beyond first four years Tuition and fees deduction o Up to $4,000 if extended for 2012 Student loan interest deduction o Up to $2,500 of interest per tax return 40 20
Stock donations Donating publicly traded stock held more than one year o No tax on gain from selling the assets C d d t t f i k t l o Can deduct current fair market value o Deduction limit is 30% of AGI for gifts to charities (20% for non-operating private foundations) o In certain situations, it may be better to deduct tax basis rather than fair market value TIP: Don t donate stock worth less than your basis; sell it and donate the proceeds. 41 42 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 21
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 real property in a foreign country? 43 Foreign Reporting Form TD F 90-22.1 - Report of Foreign Bank and Financial Accounts o Applies to foreign financial i accounts with $10,000 000 or more o Due June 30 for the previous calendar year Form 8938 - Statement of Specified Foreign Financial Assets o Required when foreign assets exceed $50,000 o File with Form 1040 Additional reporting for ownership of foreign corporations, partnerships and trusts. Consult your tax advisor. 44 22
BUSINESS TAX PLANNING Boost your bottom line by reducing taxes Cash or Accrual? Method of Accounting Is Key! 46 23
Cash Basis Taxpayers Tax Planning Strategies Delay Billing to Delay Receipt Beware of Constructive Receipt Prepay Expenses Credit Card Charges Count! 47 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 48 24
Understanding depreciation MACRS o Generally more advantageous than straight-line method o Larger deduction in early years of asset s life o Larger deduction in early years of asset s life Bonus depreciation o 50% bonus depreciation for assets placed in service from Jan. 1, 2012, through Dec. 31, 2012 o Qualified assets include any new tangible property with a recovery period of 20 years or less No bonus depreciation after Dec. 31, 2012 49 Section 179 expensing election Allows you to deduct rather than depreciate asset purchases o Deduct up to $139,000 of purchases o Deduction phases out dollar-for-dollar when 2012 asset purchases exceed $560,000 o Only Section 179 expensing can be applied to used assets o If asset purchases exceed phase out threshold (or your income), consider 50% bonus depreciation TIP: The expensing limit and phase out threshold have dropped from their 2011 levels of $500,000 and $2 million, respectively. For 2013, these amounts are scheduled to drop again, to $25,000 and $200,000. If possible, purchase assets before year end. 50 25
Employing your children Business owners can hire their kids and deduct their pay deduct their pay o Children can earn $5,950 in 2012 and pay zero federal income tax o Children can earn an additional $5,000 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. 51 Vehicle-related tax breaks Deduct out-of-pocket expenses (fuel, insurance, depreciation, etc.) or mileage o 55.5 cents per mile for 2012 Purchases of new or used vehicles may be eligible for Sec. 179 expensing New vehicles may be eligible for bonus depreciation Depreciation limit is $3,160 for autos placed in service in 2012 o Increased by $8,000 for autos eligible for bonus depreciation Additional rules and limits apply 52 26
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 53 Credits More Valuable than Deductions! Federal and California o Research & Development o Low Income Housing Federal Only o Hire Heroes Act Credit o Small Employer Health Insurance Credit California Only o Job s Credit o Enterprise Zone Hiring & Sale or Use Tax Credit 54 27
Plans for Business Owners Profit-Sharing Plan o Defined contribution plan allows discretionary employer contributions Simplified Employee Pension (SEP) o Defined contribution plan provides benefits similar to profit-sharing plan Defined Benefit Plan o Sets future pension benefit and sets contributions needed to attain benefit Warning! With defined benefit plans, employer contributions are generally required and must be paid quarterly if there was a shortfall in funding for the prior year 55 Profit Sharing Plan vs. SEP Profit Sharing Plan o Make 2012 contributions as late as due date for your 2012 tax return (including extensions) o Plan must exist on Dec. 31, 2012 o Flexibility in plan design SEP o Can set up in 2013 and still make 2012 contributions up to due date of 2012 income tax return (including extensions) o Easy to administer o Downside: Maximum allowable contribution may be less and more stringent employee coverage may be required 56 28
How Do They Stack Up for 2012? Plan Profit Sharing Maximum Contribution $50,000 000 (or $55,500) 500) SEP $50,000 (or $55,500) Defined Benefit Actuarially Determined 57 One Final Strategy! Captive Insurance Company What is it? How does it work? Pays Premiums Company Provides Insurance Captive Insurance Company 58 29
Captive Insurance Company Licensed insurance company Special rules apply pp y Premiums paid by Company are deductible expenses (IRC 162) Premiums received by Captive up to $1.2 million are tax free (IRC 831(b)) Captive pays expenses and claims, if any; retains the differences between premiums received and expenses paid as profit. 59 Tax Planning One Size Does Not Fit All 60 30
Thank you for attending HMWC CPAs & Business Advisors Please contact us for assistance: Curtis Campbell curtis@hmwccpa.com Janet Anderson janet@hmwccpa.com 31