16 Tax Issues Facing Small Business Owners in 2014

2014 will be a challenging tax year for businesses and higher-income taxpayers. The following issues are concerns that may impact you and your company’s tax liability in the new year. 

• Small Business Health Insurance Credit – The tax credit to small employers (25 or fewer equivalent full-time employees) that provide an affordable health insurance plan for their employees and supplement at least half the premiums, will increase to 50% of the employer’s contribution in 2014, up from 35% in 2013. For non-profit employers, the credit will be 35% in 2014.

• Net Investment Income Tax – As part of the Patient Protection & Affordable Care Act (the new health care legislation sometimes referred to as “Obamacare”), a new tax kicked in for 2013 and will continue in 2014 and beyond. It is a surtax levied on the net investment income of taxpayers in the higher-income brackets. And although it is perceived as an additional tax on higher-income taxpayers, it can affect even those who normally don’t have higher income if they have a large income from the sale of real estate, certain business assets, stocks, or other investments. This is on top of the  20% long-term capital gain tax rate now in effect for higher-income taxpayers.
• Higher Tax Rates – Prior to the increase in 2013, there were six tax brackets: 10, 15, 25, 28, 33, and 35%. Beginning in 2013 and continuing for future years, a new top rate of 39.6% has been added for higher-income taxpayers.
• Higher Capital Gains Rates – Beginning in 2013 and continuing for future years, the tax rate for long-term capital gains and qualified dividends has been increased to 20% (up from 15%) for taxpayers with incomes exceeding the threshold for their filing status.
• Medical AGI Phase-out – Beginning in 2013 and continuing for future years, a taxpayer’s medical deductions will be reduced by 10% of their adjusted gross income, up from the previous 7.5% (but the 7.5% continues to apply to seniors through 2016).
• Possibility of Lower Expensing Deductions – The Sec 179 business expensing allowance for business equipment drops from $500,000 per year to $25,000 in 2014 unless Congress extends the more liberal amount.⁽¹⁾
• Bonus Depreciation Expires – Beginning in 2014, the 50% bonus depreciation for tangible business assets will expire unless Congress extends it.⁽¹⁾ This also reduces the first-year maximum depreciation deduction for business autos and small trucks.
• Individual Insurance Mandate – Beginning in 2014, the Patient Protection & Affordable Care Act will impose the new requirement that U.S. persons, with certain exceptions, have minimum essential health care insurance, or face a penalty.
• Large Employer Mandatory Insurance Requirement – Originally scheduled to begin in 2014 but delayed until 2015 because the government did not have the reporting mechanisms in place, large employers, generally those with 50 or more full-time equivalent employees in the prior calendar year, that:

o    Do not offer health coverage for all its full-time employees,

o    Offer minimum essential coverage that is unaffordable (employee contribution being more than 9.5% of the employee’s household income), or

o    Offer minimum essential coverage where the plan’s share of the total allowed cost of benefits is less than 60% (i.e., less than the bronze plan coverage),

will be required to pay a penalty if any of its full-time employees were certified to the employer as having purchased health insurance through a state or federal exchange and qualified for either tax credits or a cost-sharing subsidy.

• Simplified Home Office Deduction – Effective for tax years beginning in 2013 and continuing for 2014 and beyond, taxpayers can elect a simplified deduction for the business use of the taxpayer’s home. The deduction is $5 per square foot with a maximum square footage of 300. Thus, the maximum deduction is $1,500 per year. Eligibility qualifications are the same whether the simplified or regular deduction is claimed.
• Increased Payroll and Self-Employment Tax – As part of the new health care legislation, higher-income taxpayers are faced with an additional 0.9% health insurance (HI) tax. Starting in 2013, and continuing for future years, this surtax is imposed upon wage earners and self-employed taxpayers whose wage and self-employment income exceeds $250,000 for married taxpayers filing jointly ($125,000 if filing separately) and $200,000 for all others.
• Pease Limitations – The Pease limitation on itemized deductions that was reinstated in 2013 will continue for 2014. The Pease limitation phases out certain itemized deductions for higher-income taxpayers.
• Phase-out of Exemptions - The phase-out of exemptions for higher-income taxpayers that was reinstated in 2013 continues for 2014.
• Longer Depreciation Life for Leasehold and Restaurant Property – The current 15-year depreciable life will increase to 39 years in 2014.⁽¹⁾  
• Qualified Small Business Stock Gain Exclusion – Beginning for qualified small business stock issued in 2014, the gain exclusion drops from 100% to 50%.
• Qualified Real Property Expensing – Congress temporarily permitted the use of the Sec 179 expensing deduction to write off certain leasehold improvements, and restaurant and retail property improvements. Without Congressional intervention, this provision will no longer be available in 2014.

⁽¹⁾  Congress, a few years back, engaged in brinkmanship with last-minute tax changes. Normally, they have managed to finalize tax law by year’s end. However, for 2013, they adjourned without addressing the issue of extending many tax breaks that were set to expire at the end of 2013. It is not known if these tax provisions will be extended or not.

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Did You Take Your Required Minimum Distribution for 2013?

Article Highlights

• In the year you reach 70½, you become subject to the required minimum IRA distribution rules.
• Failure to take the required minimum distribution can result in a 50% penalty.
• The penalty can be waived under certain circumstances.
• IRA-to-charity transfers are possible in 2013.

The IRS does not allow IRA owners to indefinitely keep funds in a Traditional IRA. Eventually, assets must be distributed and taxes must be paid. If there are no distributions, or if the distributions are not large enough, the IRA owner may have to pay a 50% penalty on the amount that was not distributed as required. Generally, required distributions begin in the year when the IRA owner reaches the age of 70½.

IRA owners must take at least a required minimum distribution (RMD) amount from their IRA each year, which starts with the year they reach age 70½. A taxpayer who fails to take a RMD in the year when age 70½ is reached can avoid a penalty by taking that distribution no later than April 1^st of the following year. However, that means the IRA owner must take two distributions in the following year, one for the year in which age 70½ is reached and one for the current year.

For purposes of determining the RMD, all Traditional IRA accounts—including SEP-IRAs— owned by an individual must be taken into consideration. The minimum amount that must be withdrawn in a particular year is the value of the IRA account at the end of the business day on December 31^st of the prior year, divided by the number of years the IRA owner is expected to live based on the IRS life expectancy tables and using the taxpayer’s oldest age for the year.

The RMD can be taken all at once, sporadically, or in a series of installments (monthly, quarterly, etc.) as long as the total distributions for the year are at least the minimum required amount.

Distributions that are less than the RMD for the year are subject to a 50% excise tax penalty. The IRS may waive the penalty if the failure to withdraw the minimum amount or part of the minimum amount was due to reasonable error, and the owner has taken, or is taking, steps to remedy the insufficient distribution.

For 2013, you can also directly transfer up to $100,000 from your IRA to a charity, thereby avoiding the income on your tax return. Such a transfer can count toward your RMD requirement. Although you get no charitable deduction as the contribution is excluded from income, it essentially allows taxpayers to deduct the charitable contribution without itemizing. Also, a charitable transfer effectively reduces your income, which in turn can reduce your taxable Social Security and other tax limitations based on income.

If you have questions regarding your RMD for 2013 or how an IRA-to-charity transfer can benefit you, please call our office.

(601) 649-5207

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Mandatory Health Insurance Starts Next Month—Are You Ready?

Beginning in January, everyone, with certain exceptions, is required to have minimum, essential health care insurance. This issue has received a significant amount of press coverage recently, both negative and positive. Regardless of your opinion related to the issue, the mandatory insurance requirement, together with the accompanying penalties for not being insured, premium assistance credits, and insurance subsidies, all begin in 2014. The new marketplace, also called exchanges, where insurance policies can be purchased, have debuted already, but with mixed success. These new provisions are all part of the Affordable Care Act that are being phased in over a number of years.

How this will affect you and your family will depend upon a number of issues:

Already insured – If you are already be insured through an employer plan, Medicare, Medicaid, the Veterans Administration, or a private plan that provides minimal, essential health care, then you will not be subject to any penalties under this new law.

Those exempt from the mandatory insurance requirement – The following individuals are exempt from the insurance mandate, and will not be subject to a penalty for being uninsured:

• Individuals who have a religious exemption
• Those not lawfully present in the United States
• Incarcerated individuals
• Those who cannot afford coverage based on formulas contained in the law
• Those who have an income below the federal income tax filing threshold
• Those who are members of Indian tribes
• Those who were uninsured for short coverage gaps of less than three months
• Those who have received a hardship waiver from the Secretary of Health and Human Services, who are residing outside of the United States, or who are bona fide residents of any possession of the United States.

Help for those who can’t afford coverage – Individuals and families whose household income is between 100% and 400% of the federal poverty level will qualify for a varying amount of subsidies to help pay for the insurance in the form of a Premium Assistance Credit. The lower the income, the more substantial the credit, which slowly phases out as the income increases, and is totally eliminated when the income reaches 400% of the poverty level. For those in the lower income levels, the subsidy will usually cover the bulk of the insurance costs.

To qualify for that credit, the insurance must be acquired from an insurance exchange operated by the individual’s or family’s resident state, or by the federal government when the state does not have an exchange. These exchanges have been up and running (more or less) since October 1, 2013, allowing individuals and families to apply for coverage which will become effective as of January 1, 2014.

It is important to note that the subsidy is really a tax credit based upon family income. It can be estimated in advance, and used to reduce the monthly insurance premiums; it can be claimed as a refundable credit on the tax return for the year; or it can be some combination of both. However, it is based upon the current year’s income and must be reconciled on the tax return for the year. If too much was used as a premium subsidy, some portion may need to be repaid. If there is an excess, it is refundable.

If household income is below 100% of the poverty level, the individual or family qualifies for Medicaid.

Penalty for noncompliance – The penalty for noncompliance will be the greater of either a flat dollar amount or a percentage of income:

• For 2014, $95 per uninsured adult ($47.50 for a child), or 1 percent of household income over the income tax filing threshold
• For 2015, $325 per uninsured adult ($162.50 for a child), or 2 percent of household income over the income tax filing threshold
• For 2016 and beyond, $695 per uninsured adult ($347.50 for a child), or 2.5 percent of household income over the income tax filing threshold

Flat dollar amounts – The flat dollar amount for a family will be capped at 300% of the adult amount. For example, in 2014, the first year for the penalty, the maximum penalty for a family will be $285 (300% of $95). But for 2016, the maximum penalty jumps to $2,085 (300% of $695). The child rate will apply to family members under the age of 18.

Overall penalty cap – The overall penalty will be capped at the national average premium for a minimal, essential coverage plan purchased through an exchange. This amount won’t be known until a later date.

If you have any questions as to how this new insurance requirement will affect you, please call our office.

(601) 649-5207

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Small Firm Health Insurance Marketplace Postponed

Article Highlights:

• Small Employer Health Insurance Credit
• Credit Qualifications
• Administration Delays Availability from Government Marketplace until 2015

Beginning in 2010, the federal government offered small employers a tax credit as an incentive to provide health insurance to their employees. This credit was up to 35% of the employer’s contribution toward the cost of the employees’ health insurance for 2010 through 2013, with an increase to 50% starting in 2014, and then available only for two consecutive years after 2013. For non-profit employers, the credit percentages are 25% and 35%, respectively.

A small employer is one that employs 25 or fewer equivalent full-time employees with average full-time wages of $50,000 or less. That definition is misleading, since the maximum credit is only available to employers with 10 or fewer employees with average full-time wages of $25,000 or less; the credit begins to phase out as the number of employees and average full-time wages increase.

Prior to the startup of health insurance marketplaces, a small employer would qualify for the credit by purchasing group insurance on the open market and paying at least 50% of the employees’ premiums. Beginning in 2014, the credit was only supposed to be available if the insurance was purchased through the federal or state government-run marketplaces.

However, because of the problems with making the federal marketplace website functional, the Administration has announced a one-year delay to 2015 for the requirement that the insurance be acquired through a government-run insurance marketplace. This will allow small businesses to continue with their existing plans for another year, and still qualify for the credit if the insurance otherwise meets the required criteria.

If you have questions related to the small employer health insurance credit or any of the tax provisions of the Affordable Care Act being implemented in 2013 and 2014, please call our office.

(601) 649-5207

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Last Minute Tax Moves

Article Highlights:

• Year-end Tax Strategies
• Prepay Taxes if Not Subject to the AMT
• Pay Off Medical Installment Payments
• Advance Charitable Deductions
• Be Cautious of Overall Itemized Deductions Phase Out
• Prepay Tuition Expenses
• Fast Write-Offs For Business Purchases

Year’s end is rapidly approaching, but there are still some tax-advantaged moves you can make before the New Year. If you itemize deductions, you might prepay the next installment of your property taxes, pay off medical bills, and pay the fourth quarter state-estimated tax payment in advance. You might prepay college tuition to maximize education credits, and purchase business equipment to take advantage of the more beneficial write-offs available in 2013. 

Prepay Next Installment of Property Taxes – Usually, property taxes are billed in a fiscal year and can be paid all at once or in multiple installments. If you have been paying the current tax bill in installments and one of those installments is due in 2014, you can pay it before year’s end and take the deduction on your 2013 return instead of on 2014’s return.

Pay State-Estimated Taxes in Advance - If your state has a state income tax, the state income tax paid during the year is deductible as an itemized deduction on your federal tax return. The fourth quarter estimated installment for 2013 is due on January 15, 2014 for most states. If additional state income tax payments in 2013 can benefit you as an itemized deduction, paying that January installment before year’s end would allow it to be deducted in 2013.  

Caution: Taxes are not deductible if you are subject to the alternative minimum tax, and prepaying state income and property taxes might not provide any benefit.  

Pay Off Medical Bills – If you are paying medical expenses on an installment plan, you itemize your deductions, and your medical expenses for 2013 will exceed 10% of your adjusted gross income (AGI), or 7.5% for tax filers aged 65 and over, it could be beneficial to pay off the balance you owe. You can pay off those medical expenses, even with borrowed funds, before year’s end and increase your deductions for 2013.

Make Charitable Contributions – The holiday season is historically a time for making charitable contributions to qualified organizations, and if you are itemizing your deductions, the donations you make before the end of 2013 can help to reduce your 2013 tax bite. If you regularly tithe to a house of worship, you might even prepay part of your 2014 commitment and deduct it in 2013. This can be beneficial for those who only marginally itemize their deductions.

Caution: Beginning in 2013, higher income taxpayers will have their itemized deductions phased out, so if you are subject to the phase-out, these planning suggestions may not provide the benefits expected. The income threshold for the phase-out is $300,000 for joint filers, $250,000 for singles, $275,000 for heads of household, and $150,000 for married individuals filing separately.

Prepay College Tuition – If qualified tuition is paid during 2013 for an academic period that begins during the first three months of 2014, the education credit is allowed for those expenses in 2013. Thus, if your higher-education tuition expenses for yourself, your spouse, or your dependents to date for 2013 have not been enough to maximize your education credit for 2013, you might consider prepaying the tuition for the first quarter of 2014.

Purchase Business Equipment – If you have a business, and you anticipate purchasing additional equipment for the business, it may be appropriate to make the purchase(s) before the end of the year to take advantage of the bonus depreciation deduction and/or the Sec 179 expensing deduction. Equipment includes machinery, computer systems, communication systems, office furnishings, etc. Unless extended by Congress, the bonus depreciation will end after 2013, and the maximum Sec 179 deduction will decrease to $25,000 from the current $500,000.

If you have questions related to any of the suggested strategies, please call our office. 

(601) 649-5207

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December Due Dates

December 2013 Individual Due Dates

December 1 - Time for Year-End Tax Planning 

December is the month to take final actions that can affect your tax result for 2013. Taxpayers with substantial increases or decreases in income, changes in marital status or dependent status, and those who sold property during 2013 should call for a tax planning consultation appointment. 

December 10 - Report Tips to Employer 

If you are an employee who works for tips and received more than $20 in tips during November, you are required to report them to your employer on IRS Form 4070 no later than December 10. Your employer is required to withhold FICA taxes and income tax withholding for these tips from your regular wages. If your regular wages are insufficient to cover the FICA and tax withholding, the employer will report the amount of the uncollected withholding in box 12 of your W-2 for the year. You will be required to pay the uncollected withholding when your return for the year is filed.

December 31 - Last Day to Make Mandatory IRA Withdrawals

Last day to withdraw funds from a Traditional IRA Account and avoid a penalty if you turned age 70½ before 2013. If the institution holding your IRA will not be open on December 31, you will need to arrange for withdrawal before that date.

December 31 - Last Day to Pay Deductible Expenses for 2013 

Last day to pay deductible expenses for the 2013 return (doesn’t apply to IRA, SEP or Keogh contributions, all of which can be made after December 31, 2013). Taxpayers who are making state estimated payments may find it advantageous to prepay the January state estimated tax payment in December (Please call the office for more information). 

December 31 -  Caution! Last Day of the Year 

December 2013 Business Due Dates

December 16 - Social Security, Medicare and Withheld Income Tax 

If the monthly deposit rule applies, deposit the tax for payments in November. 

December 16 - Nonpayroll Withholding 

If the monthly deposit rule applies, deposit the tax for payments in November. 

December 16 - Corporations 

The fourth installment of estimated tax for 2013 calendar year corporations is due. 

December 31 - Last Day to Set Up a Keogh Account for 2013 

If you are self-employed, December 31 is the last day to set up a Keogh Retirement Account if you plan to make a 2013 Contribution. If the institution where you plan to set up the account will not be open for business on the 31st, you will need to establish the plan before the 31st. Note: there are other options such as SEP plans that can be set up after the close of the year. Please call the office to discuss your options.

December 31 - Caution! Last Day of the Year 

If the actions you wish to take cannot be completed on the 31st or a single day, you should consider taking action earlier than December 31st.

Call our office with any questions. (601) 649-5207

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Your 2013 Tax Bill May Give You A Shocker

Article Highlights

• Regular and capital gains tax rates increase for higher income taxpayers
• New 3.8% net investment income tax
• Additional 0.9% health insurance payroll and self-employment tax
• Phase-out of exemption deduction
• Phase-out of itemized deductions

Many higher-income taxpayers are in for a shock when their 2013 income tax returns are prepared. In 2013, a significant number of tax increases, and new limitations on deductions, will impact higher income taxpayers. Before you decide that you are not a higher income taxpayer, keep in mind that your income does not just include your earnings from work—it also includes gains from the sale of property, investments, business assets, and other capital items. So if you have a significant gain from a sale, even though the gain can be attributed to many years of appreciation, it is all taxable in the year of sale, and could place you in the higher income category.

It is important that you are aware of these changes, plan for them in advance, are prepared for the higher taxes, avoid underpayment penalties, and when appropriate, do some tax planning in advance to mitigate the bite of these new taxes. This article highlights many of the tax changes that take effect in 2013.

•      Higher individual income tax rates for some. Generally, the regular income tax rates remain the same at 10%, 15%, 25%, 28%, 33%, and 35%. But to the extent a single individual’s income exceeds $400,000 it will be subject to a new, 39.6% tax rate. The 39.6% threshold for joint filers and surviving spouses will be $450,000, and $425,000 for those filing as the head of household.

•      New Hospital Insurance tax. For higher income workers and self-employed individuals, an additional 0.9% hospital insurance (Medicare) tax is added to the FICA payroll tax (for employees), and self-employment tax (for self-employed individuals). This additional tax applies to wages and net self-employment income in excess of $250,000 for joint filers, $125,000 for married filing separately, and $200,000 for all others. For employees, this tax is automatically withheld from their payroll checks.

·         Surtax on unearned income. As part of the Affordable Care Act, a new tax is imposed upon the net investment income of individuals, estates, and trusts. For single individuals, the tax is 3.8% of the lesser of: (1) net investment income; or (2) the excess of modified adjusted gross income over the threshold amount of $200,000. For joint filers and surviving spouses, the threshold is $250,000, and for married taxpayers filing separately, the threshold is $125,000. Net investment income is investment income less investment expenses. Investment income includes income from interest, dividends, non-qualified annuities, royalties, rents (other than derived from a trade or business), capital gains (other than derived from a trade or business), trade or business income that is a passive activity with respect to the taxpayer, and trade or business income with respect to trading financial instruments or commodities.  

•      Increased Capital Gains. Generally the long-term capital gains and qualified dividends tax rates remain at 0% and 15%, except for the fact that a 20% rate has been added for single taxpayers with incomes exceeding $400,000. For joint filers, the threshold for the 20% rate is $450,000, and $225,000 for married individuals filing separately.  

•      Personal exemption phase-out. The personal exemption allowance for the taxpayer, a spouse, and each claimed dependent for 2013 is $3,900. For example a married couple claiming their two children as dependents would be able to deduct $15,600 (4 x $3,900) in personal exemptions when determining their taxable income. However, beginning in 2013, the exemption allowance begins to phase out for single taxpayers when their adjusted gross income exceeds the threshold amount of $250,000. The starting threshold of joint filers and surviving spouses is $300,000, $275,000 for heads of household, and $150,000 for married taxpayers filing separately. The exemption allowances are reduced by 2% for each $2,500 (or a portion thereof), by which the taxpayer’s adjusted gross income exceeds the thresholds.

•      Itemized deductions limitations. As with the exemption phase-out explained above, the itemized deductions are also phased out for 2013. The phase-out thresholds are the same as those for exemptions, and the itemized deductions are reduced by 3% of the amount by which the taxpayer’s adjusted gross income exceeds the threshold amount, with the reduction not to exceed 80% of the otherwise allowable itemized deductions. The reduction does not apply to the following deductions: medical and dental expenses, investment interest expense, casualty losses, and gambling losses.

As you can see, for some taxpayers the impact can be quite significant. However, it may not be too late to improve your situation with some year-end planning, and the sooner the better. Options include taking advantage of unrealized losses, business expensing, tax credits, delaying certain deductions and tax prepayments, income deferral, and other techniques. Please call this office for assistance.

Call Us Today!

(601) 649-5207

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You and the New Medicare Tax

Article Highlights:

• New additional 0.9% Medicare tax for higher-income taxpayers.
  
  
• Threshold for paying the tax is combined wages and net self-employment
  income of over $250,000 for married individuals and $200,000 for others.
  
  
• Certain combinations of income and marital status could result in unexpected tax liabilities and penalties.

There is a new additional Medicare tax in effect for 2013 that may require year-end actions. The new tax, which is part of the Affordable Care Act, imposes an additional 0.9% Medicare (HI) tax on some higher-income taxpayers. The threshold for paying the tax is combined wages and net self-employment income of over $250,000 for married individuals and $200,000 for others. (Taxpayers who do not have wage or self-employment income—for example, retirees or those with only investment income—are not subject to this new tax, regardless of the amount of their income.)

Employers are required to begin withholding the additional tax from an employee’s wages when the employee’s wage income exceeds $200,000. There are situations in which this will generate an additional refund and situations in which the withholding will be insufficient, creating an unexpected year-end tax liability and possibly penalties. 

Here are some situations that may need your attention:

• A married couple, both working for wages, and neither has wages in excess of $200,000, but the combination of wages exceeds $250,000. They will be liable for the full additional 0.9% tax on their combined wages that exceed $250,000 because neither of their employers withheld any of the additional Medicare tax. 
• A single individual has two separate jobs, neither producing wages in excess of $200,000, but the combination of wages exceeds $200,000. The individual will be liable for the full additional 0.9% tax on his or her combined wages that exceed $200,000 because neither of the employers will have withheld any of the additional Medicare tax. 
• A single individual has both wages and self-employment income, and the combination exceeds the $200,000 threshold. The individual will need to pay the extra Medicare tax on the combination of the wages and net self-employment income in excess of $200,000.  

These and similar situations can lead to unexpected tax liability and can cause an underpayment penalty to be assessed. Also, in determining whether taxpayers may need to make adjustments to avoid a penalty for underpayment of the estimated tax, individuals should also be mindful that the additional Medicare tax might be over-withheld. This could occur, for example, in a situation in which only one spouse of a married couple works and reaches the threshold for the employer to withhold, but the couple's income won't exceed the $250,000 threshold to actually cause the tax to be owed.

In all of these (and other) situations, a new form in the taxpayers’ 2013 returns will be used to reconcile the Medicare tax that was withheld, if any, and the actual additional Medicare tax liability.

If you think you might be subject to this new tax and have questions or need assistance projecting your 1040 results and potential for unexpected tax liabilities and penalties, please give our office a call.

(601) 649-5207

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Fine Tuning Capital Gains and Losses

Article Highlights

•          Long-term capital gains rates are zero to the extent that the taxpayer is in the 10 or 15% regular tax bracket.
•          Long-term capital rates are 15% to the extent that the taxpayer is in the 25% through the 35% regular tax bracket.
•          Long-term capital rates are 20% to the extent that the taxpayer is in the 39.6% regular tax bracket.
•         Both short-term and long-term capital gains are subject to the new 3.8% surtax on net investment income for higher-income taxpayers. 
•          Significant tax savings may be achieved by planning and timing gains and losses.

Year-end has historically been a good time to plan tax savings by carefully structuring capital gains and losses. Conventional wisdom has always been to minimize gains by selling “losers” to offset the gains from “winners” and where possible, generate the maximum allowable $3,000 capital loss for the year.

Long-term capital losses offset long-term capital gains before they offset short-term capital gains. Similarly, short-term capital losses offset short-term capital gains before they offset long-term capital gains (“long-term” means that the stock or property has been held over one year). Keep in mind that taxpayers may use up to $3,000 of total capital losses in excess of total capital gains as a deduction against ordinary income in computing adjusted gross income (AGI). Individuals are subject to federal income tax at a rate as high as 39.6% on short-term capital gains and ordinary income. But long-term capital gains are generally taxed at a maximum rate of 15 or 20%.

All of this means that having long-term capital losses offset long-term capital gains should be avoided where possible, since those losses will be more valuable if they are used to offset short-term capital gains or ordinary income. Avoiding this requires ensuring that the long-term capital losses are not taken in the same year as the long-term capital gains. However, this is not just a tax issue; investment factors also need to be considered. It would be unwise to defer recognizing gain until the following year if there is too much risk that the property’s value will decline before it can be sold. Similarly, one wouldn’t want to risk increasing a loss on property that is expected to continue declining in value by deferring its sale until the following year.

To the extent that taking long-term capital losses in a different year than long-term capital gains is consistent with good investment planning, a taxpayer should take steps to prevent those losses from offsetting those gains.

Increased Capital Gains Rates - The special long-term capital gains rates that have been in effect since 2003 are revised as of 2013 and for future years without further Congressional tinkering. The capital gains rates are now 0% to the extent that your marginal tax rate is 10 or 15%, and 15% to the extent your marginal rate is between 25 and 35%. This means that the 15% capital gains rate will apply for individuals who file the single status with taxable income in 2013 between $36,251 and $400,000. The 15% capital gains rate for married couples filing jointly will be in effect if their 2013 taxable income is between $72,501 and $450,000. For higher income taxpayers – those in the 39.6% tax bracket – the capital gains rate increases to 20%.      

Individuals with large long-term capital gains in their investment portfolios might consider taking a profit up to the amount that would be taxed at 0%. The good news here is that the wash sale rules do not apply to assets sold at a gain. So if you like a stock, you are free to buy it back right away. If your state doesn’t have a lower tax rate on capital gains, then the additional state tax you’d pay from selling profitable capital assets will need to be weighed against the federal tax you’d potentially save when deciding whether to make tax sales before year-end.

Example: You are single with an annual taxable income (income minus deductions and exemptions), before including any stock gains, of $30,000. Thus, the first $6,251 ($36,251 - $30,000) of capital gains added to your income will be in the zero capital gains tax bracket (no tax). The next $363,749 ($400,000 - $36,251) of capital gains (without considering the 3.8% surtax on net investment income discussed later) would be taxed at 15%. After that, any additional capital gains are taxed at 20%. Thus when you take a gain, it can have a significant impact on the amount of tax you pay and careful planning can minimize the tax. This gives rise to the following strategies:

• If in any year some portion of your gain will be taxed at the zero capital gain rate you should probably take that amount of gain since it produces no tax.
• If you have a substantial gain, and some of it is added to your other income, it will push some portion of the gain into the 20% capital gains bracket and you may be able to spread the gain over two or more years and keep more of the gain in the 15% capital gains bracket. This is done by structuring the sale as an installment sale. Unfortunately, the law doesn’t allow installment sales for publicly traded securities, so this strategy won’t work when you sell most stocks and bonds, but could be used when selling real estate.

• Increased Marginal Tax Rates – Beginning in 2013, the marginal rates are 10, 15, 25, 28, 33, 35 and 39.6%, the highest rate being a new one. These rates apply to “ordinary” income including short-term capital gains.

Conventional wisdom has always been to defer income, but depending upon your tax bracket and future anticipated income, it may be appropriate to consider accelerating your income to take advantage of a lower tax rate.

• Surtax on Net Investment Income - One should also be aware of the 3.8% Net Investment Income (NII) Tax taking effect in 2013. It will apply to higher-income taxpayers. This new tax, part of the healthcare reform legislation, imposes a 3.8% surtax on the lesser of net investment income (investment income less investment expenses) or the amount that the modified adjusted gross income exceeds a threshold of $200,000 ($250,000 for joint filers and $125,000 for married individuals filing separately). Taking a large gain in one year can increase your income and make you susceptible to the NII tax. However, where possible you might spread that gain over two or more years, and avoid the surtax by using the installment sale method mentioned above.

Of course all of these tax-saving suggestions will go out the window if there is an overriding investment strategy or if there are investment risks to consider.

It may be in your best interest to review your current year tax strategy with an eye to the future in order to maximize your benefits from gains or losses associated with capital assets. Please call our office for assistance.

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Avoid Home Cancellation of Debt Income

Article Highlights

• Forgiven debt is taxable.

• Forgiven home mortgage acquisition debt is excludable.

• Without a last-minute congressional extension, the home mortgage acquisition debt exclusion expires at the end of 2013.

When a taxpayer settles a debt for less than its full amount, the forgiven amount of the debt is taxable, unless the taxpayer qualifies for one of two currently available exclusions. With the downturn in the economy and the accompanying drop in home prices that occurred in recent years, many taxpayers are unable to keep up the mortgage payments on their home, and unable to sell their homes because they owe more than the market price. As a result, a large number of homeowners have let their homes go back to the lender.

Congress offered help for those in this situation by providing an exclusion from income of the forgiven acquisition debt from a taxpayer’s principal residence. If a taxpayer’s home is upside down, and they are considering letting it go back to the lender, they should be aware that unless Congress provides a last-minute extension, this Principal Residence Acquisition Debt Relief Exclusion will expire at the end of 2013. The only other exclusion available is the insolvent taxpayer exclusion, which limits the amount that can be excluded to the excess of the taxpayer’s total debts over the taxpayer’s total assets.

An individual not able to exclude the forgiven debt on their home using the insolvent taxpayer exclusion may wish to act before year’s end. The tax implications of forgiven debt are very complicated and not all the details are covered in this article. You are strongly urged to contact our office if you are contemplating letting your home go back to the bank.

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