3 tax increases under the fiscal cliff deal
As Congress and the President negotiate on how to address the fiscal cliff, it’s still unclear whether the 15% rate will be extended - especially for higher-income taxpayers.
Business-related purchases of new or used vehicles may be eligible for Section 179 expensing, and business-related purchases of new vehicles may be eligible for bonus depreciation. But Sec. 179 expensing limits are scheduled to go down in 2013, and bonus depreciation is scheduled to disappear. So you might benefit from purchasing business vehicles before year end.
Self-employed? Set up a retirement plan by Dec. 31!
Save more tax with donations of appreciated stock
In 2012, taking the opposite approach might be better. If it’s likely you’ll be in a higher tax bracket next year, accelerating income and deferring deductible expenses may save you more tax. And, because individual income tax rates are scheduled to go up in 2013, if your business structure is a flow-through entity, you may face higher rates even if your tax bracket remains the same.
The long-term capital gains rate is currently 0% for gain that would be taxed at 10% or 15% based on the taxpayer’s ordinary-income rate. But the 0% rate is scheduled to expire after 2012. To lock it in, you may want to transfer appreciated assets to adult children or grandchildren in one of these tax brackets in time for them to sell the assets by year end.
If you have a traditional IRA, you might benefit from converting all or a portion of it to a Roth IRA. A conversion can allow you to turn tax-deferred future growth into tax-freegrowth. It also can provide estate planning advantages: Roth IRAs don’t require you to take distributions during your life, so you can let the entire balance grow tax-free over your lifetime for the benefit of your heirs.
The downside of a conversion is that the converted amount is taxable in the year of the conversion. But there are a couple of reasons why 2012 may be the right year to make the conversion and take the tax hit:
1. Saving income taxes. Federal income tax rates are scheduled to increase for 2013 and beyond unless Congress extends current rates or passes other rate changes. So if you convert before year end, you’re assured of paying today’s relatively low rates on the conversion. In addition, you’ll avoid the risk of higher future tax rates on all postconversion growth in your new Roth account, because qualified Roth IRA withdrawals are income-tax-free.
2. Saving Medicare taxes. If you convert in 2012, you don’t have to worry about the extra income from a future conversion causing you to be hit with the new 3.8% Medicare tax on investment income, which is scheduled to take effect in 2013 under the health care act. While the income from a 2013 (or later) conversion wouldn’t be subject to the tax, it would raise your modified adjusted gross income (MAGI), which could cause some or all of your investment income in the year of conversion to be hit with the Medicare tax.
Likewise, you won’t have to worry about future qualified Roth IRA distributions increasing your MAGI to the extent that it would trigger or increase Medicare tax on your investment income, because such distributions aren’t included in MAGI. While traditional IRA distributions won’t be subject to the Medicare tax, they will be included in MAGI and thus could trigger or increase the Medicare tax on investment income.
Congress recesses until after the election; tax law uncertainty remains
After being in session for only two weeks in September, Congress has now adjourned until after the November 6 elections — without reducing any tax law uncertainty. The "lame duck" session is the next possibility for legislative activity. The Senate will return for the week of Nov. 15, break for the week of Thanksgiving and return again on Nov. 29 for a period of time yet to be determined. The House's schedule likely will be similar.
Congress has a full plate awaiting them in the lame duck session. This includes addressing tax breaks that expired at the end of 2011 as well as the rates and breaks that are scheduled to expire at the end of this year.
The results of the election should shed some light on what Congress will try to accomplish in the lame duck session — and what they'll punt to next year. (In terms of the latter, tax law changes could be made retroactive.)
According to popular wisdom, the Republican leadership may be more likely to strike an agreement with Democrats on the substance of extending tax cuts if President Obama is re-elected. If Gov. Romney is elected, Republicans would have less reason to compromise.
Other election results that will affect legislative action are which party will control the Senate and by what margin. The Republicans are expected to retain control of the House, but also significant will be how many of the Tea Party members elected two years ago retain their House seats.
As tax law uncertainty continues, year-end tax planning remains a challenge. It's a good idea to perform a year-to-date review of your income, deductions and potential tax now. That way you can be ready to take quick action once it's clear what, if any, tax law changes Congress will make before year-end.
Veterans provide a valuable labor pool, full of highly trained, hard-working team players with strong leadership skills. There's also a tax incentive: The VOW to Hire Heroes Act of 2011 extended the Work Opportunity credit through 2012 for employers that hire qualified veterans. It also expanded the credit by:
To be eligible for the credit, you must take certain actions before and shortly after you hire a qualified veteran. We can help you determine what you need to do.
How to verify that a charity is eligible to receive tax-deductible contributions
Donations to qualified charities are generally fully deductible, and they may be the easiest deductible expense to time to your tax advantage. After all, you control exactly when and how much you give. But before you donate, it's critical to make sure the charity you're considering is indeed a qualified charity — that it's eligible to receive tax-deductible contributions.
The IRS's recently launched online search tool, Exempt Organizations (EO) Select Check, can help you more easily find out whether an organization is eligible to receive tax-deductible charitable contributions. The previous source for this information was IRS Publication 78, which is incorporated in the new tool.
You can access EO Select Check athttp://apps.irs.gov/app/eos. Information about organizations eligible to receive deductible contributions is updated monthly.
Finally, in an election year, it's important to remember that political donations aren't tax-deductible.
2012 may be the last year to use tax-free ESA funds for precollege expenses
Coverdell Education Savings Accounts (ESAs), like 529 savings plans, offer a tax-smart way to fund education expenses:
However, if Congress doesn't extend this treatment, distributions used for precollege expenses will be taxable starting in 2013. So you can't count on using tax-free ESA funds to pay these expenses next year — which essentially means as soon as the second half of the new school year.
Barring congressional action, ESAs will become less attractive in 2013 for an additional reason: The annual ESA contribution limit per beneficiary, currently $2,000, will go down to $500 for 2013. Contributions (both in 2012 and 2013) are further limited based on income.
Turning a business trip into a vacation
Bringing family or friends along on a business trip and extending your stay can be an excellent way to fund a portion of your vacation costs and save taxes. But if you’re not careful, you could lose the tax benefits.
Generally, if the primary purpose of your trip is business, then expenses directly attributable to business will be deductible (or excludable from your taxable income if your employer is paying the expenses or reimbursing you through an accountable plan). Reasonable and necessary travel expenses generally include:
Expenses associated with taking extra days for sightseeing, relaxation or other personal activities generally aren’t deductible. Nor is the cost of your spouse or children traveling with you.
How do you determine if your trip is “primarily” for business? One factor is the number of days spent on business vs. pleasure. But some days that you might think are “pleasure” days might actually be “business” days for tax purposes. “Standby days,” for example, may be considered business days, even if you’re not engaged in business-related activities. You also may be able to deduct certain expenses on personal days if tacking the days onto your trip reduces the overall cost.
During your trip it’s critical to carefully document your business vs. personal expenses. Also keep in mind that special limitations apply to foreign travel, luxury water travel and certain convention expenses. For example, no deduction is allowed for expenses relating to a convention, seminar or meeting held outside North America unless it’s reasonable for the meeting to be held there.
Now’s the time for giving
For 2012, the gift and estate tax exemption is $5.12 million and the maximum gift and estate tax rate is 35%. Absent additional legislation, for 2013 the exemption will drop to $1 million and the top tax rate will increase to 55%. It’s difficult to predict what Congress will do between now and then, so consider making large gifts before year end to take advantage of the high exemption amount.
Even if Congress extends the current law, there are advantages to making gifts early, especially gifts of assets expected to appreciate. That’s because future appreciation is removed from your estate and sheltered from gift and estate taxes.
A caveat: If the exemption does fall back to $1 million in 2013, the IRS might attempt to “claw back” previous gifts in excess of $1 million and subject them to estate tax, even though they were exempt from gift taxes when made. Most experts believe this outcome is unlikely, but if it happens, you’ll be no worse off for having made the gift, and you may be better off if the assets appreciate after the gift is made.
Congress recesses without reducing tax law uncertainty
Congress has adjourned for its August recess and we still have no extensions of tax law provisions that expired at the end of 2011 or any definitive answers on what will happen to tax rates and breaks set to expire at the end of this year. While the House and Senate each passed its own tax bill, no compromises were made that would allow either bill to generate sufficient votes in the other chamber.
Congress isn’t scheduled to return until Sept. 10, and many pundits believe no tax law changes will be passed by both the House and Senate until the lame duck session after the Nov. 6 election. Still others believe nothing will happen until the new year, with changes made retroactive to the beginning of 2012 or 2013 (depending on when a particular provision expired).
This continued uncertainty makes tax planning a challenge. For example, it’s difficult to determine how to best time your income and deductible expenses when you don’t know whether your tax rate will go up, go down or remain the same next year. Deferring income to the next year and accelerating deductible expenses into the current year typically is a good idea, because it will defer tax, which is usually beneficial.
But when you expect to be in a higher tax bracket next year — or you expect tax rates to go up — the opposite approach may be beneficial: Accelerating income will allow more income to be taxed at your current year’s lower rate. And deferring expenses will make the deductions more valuable, because deductions save more tax when you’re subject to a higher tax rate.
Health care law requires employers to make a change to their FSAs starting in 2013
Now that the U.S. Supreme Court has upheld the Patient Protection and Affordable Care Act of 2010, businesses need to start preparing for provisions that will go into effect in 2013 (unless Congress repeals them). One such provision is a new limit on employee contributions to health care Flexible Spending Accounts (FSAs).
Employees can redirect pretax income to FSAs, which then pay or reimburse them for medical expenses not covered by insurance. Currently, employers that offer FSAs can set the employee contribution limits for them. But starting in 2013 the health care act applies a $2,500 limit to employee contributions. (However, there will continue to be no limit on employer contributions to FSAs. Also note that a $5,000 employee contribution limit already applies to child and dependent care FSAs.)
According to the IRS, the $2,500 limit on pretax employee FSA contributions applies on a plan year basis. Thus, non-calendar-year plans must comply for the plan year that starts in 2013. Employers will need to amend their plans and summary plan descriptions to reflect the $2,500 limit (or a lower one, if they wish) and institute measures to ensure employees don’t elect contributions that exceed the limit.
Tax rules you should know if you rent out your vacation home
If you rent out all or a portion of your vacation home for less than 15 days, you don’t have to report the income. But expenses associated with the rental won’t be deductible.
If you rent out your vacation home for 15 days or more, you’ll have to report the income. But you also may be entitled to deduct some or all of your rental expenses — such as utilities, repairs, insurance and depreciation. Exactly what you can deduct depends on whether the home is classified as a rental property for tax purposes (based on the amount of personal vs. rental use):
Rental property. You can deduct rental expenses, including losses, subject to the real estate activity rules. You can’t deduct any interest that’s attributable to your personal use of the home, but you can take the personal portion of property tax as an itemized deduction.
Nonrental property. You can deduct rental expenses only to the extent of your rental income. Any excess can be carried forward to offset rental income in future years. You also can take an itemized deduction for the personal portion of both mortgage interest and property taxes.
In some situations, it may be beneficial to adjust your personal use of a vacation home — or the number of days you rent it out — so that it will be classified in a more beneficial way for tax purposes.
Opening the “back door” to a Roth IRA
A potential downside of tax-deferred saving through a traditional retirement plan is that you’ll have to pay taxes when you make withdrawals at retirement. Roth plans, on the other hand, allow tax-free distributions; the tradeoff is that contributions to these plans don’t reduce your current-year taxable income.
Unfortunately, modified adjusted gross income (MAGI)-based phaseouts may reduce or eliminate your ability to contribute:
You can make a partial contribution if your MAGI falls within the applicable range, but no contribution if it exceeds the top of the range.
If the income-based phaseout prevents you from making Roth IRA contributions and you don’t already have a traditional IRA, a “back door” IRA might be right for you. How does it work? You set up a traditional account and make a nondeductible contribution to it. You then wait until the transaction clears and convert the traditional account to a Roth account. The only tax due will be on any growth in the account between the time you made the contribution and the date of conversion.
Have you misclassified workers as independent contractors?
An employer enjoys several advantages when it classifies a worker as an independent contractor instead of an employee. For example, it isn’t required to pay payroll taxes, withhold taxes, pay benefits or comply with most wage and hour laws. However, there’s a potential downside: If the IRS determines that workers have been improperly classified as independent contractors rather than employees, the employer can be subject to significant back taxes, interest and penalties.
To determine whether a worker is an employee or an independent contractor, the IRS considers three categories of factors related to the degree of control and independence:
1. Behavioral. Does the employer control, or have the right to control, what the worker does and how the worker does his or her job?
2. Financial. Does the employer control the business aspects of the worker’s job? Does the employer reimburse the worker’s expenses or provide the tools or supplies to do the job?
3. Type of relationship. Will the relationship continue after the work is finished? Is the work a key aspect of the employer’s business?
The determination of the proper classification under these factors may not always be clear. Fortunately, the IRS offers two programs that may provide some relief: 1) the Classification Settlement Program (CSP), which is available to employers undergoing an audit and allows qualified employers to prospectively reclassify workers as employees, and 2) the Voluntary Classification Settlement Program (VCSP), which allows employers to reclassify workers as employees at a relatively low tax cost outside of the audit process and without the need to go through the normal administrative correction processes.
Supreme Court health care decision could mean higher taxes in 2013
Now that the U.S. Supreme Court has generally upheld 2010’s health care act, it’s important to consider how it will affect your tax liability. One way might be your Medicare tax liability.
Under the act, starting in 2013, higher-income taxpayers will be subject to an additional 0.9% tax on wages and self-employment income that exceed specified thresholds, generally $200,000 for single filers and heads of households and $250,000 for married taxpayers filing jointly ($125,000 for married taxpayers filing separately).
On top of that, taxpayers are scheduled to be subject to a new 3.8% Medicare tax on net investment income to the extent that their modified adjusted gross income (MAGI) exceeds specified thresholds, also generally $200,000 for single filers and heads of households and $250,000 for married taxpayers filing jointly ($125,000 for married taxpayers filing separately).
Investment income does not include distributions from IRAs, pensions, 401(k) plans or other qualified retirement plans. But distributions from these plans could trigger additional Medicare taxes on net investment income by increasing MAGI.
If your income might be high enough to subject you to these additional taxes next year, consider accelerating income into 2012 where possible. However, you’ll need to keep in mind whether such actions could trigger the alternative minimum tax.
Also consider whether, before year end, you should sell highly appreciated assets you’ve held long term. It may make sense to recognize gains now rather than risk paying Medicare tax on them next year.
These strategies may also prove beneficial if ordinary and long-term capital gains rates increase as scheduled next year. But keep an eye on Congress: A repeal of the provision imposing the additional Medicare tax (as well as an extension of current income and long-term capital gains rates) could occur.