Understanding Tax Terminology

Article Highlights

• Filing status can be single, married filing jointly, married filing separately, head of household, or surviving spouse with dependent child.
• Adjusted gross income (AGI) is the sum of a taxpayer’s income minus specific subtractions called adjustments. Modified AGI is the regular AGI with certain adjustments and exclusions added back.
• Taxable income is AGI less deductions and exemption.
• Marginal tax rate is the tax percentage at which the top dollar of your income is taxed. Also referred to as your tax bracket.
• Alternative minimum tax (AMT) is a tax that you pay if it is higher than tax computed the regular way.  Certain deductions, credits and tax benefits are not allowed when computing the AMT.
• Credits reduce your tax dollar-for-dollar and some are refundable.
• Failing to prepay enough tax through withholding or estimated payments can result in an underpayment of estimated tax penalty.
  
  

No matter what the season or your unique circumstances, when it comes to your taxes, planning usually pays off in a lower tax bill. It can be difficult to understand tax strategies if you are not familiar with the terminologies used in taxation. The following provides you with the basic details associated with the most frequently encountered tax terms.   

• Filing Status—Generally, if you are married at the end of the tax year, you have three possible filing status options: married filing jointly, married filing separately, or, if you qualify, head of household. If you were unmarried at the end of the year, you would file as single, unless you qualify for the more beneficial head-of-household status. A special status applies for some widows and widowers.

Head of household is the most complicated filing status to qualify for and is frequently overlooked as well as incorrectly claimed. Generally, the taxpayer must be unmarried AND:

• pay more than one half of the cost of maintaining his or her home, a household that was the principal place of abode for more than one half of the year of a qualifying child or an individual for whom the taxpayer may claim a dependency exemption, or
• pay more than half the cost of maintaining a separate household that was the main home for a dependent parent for the entire year.

A married taxpayer may be considered unmarried for the purpose of qualifying for head-of-household status if the spouses were separated for at least the last six months of the year, provided the taxpayer maintained a home for a dependent child for over half the year.

Surviving spouse (also referred to as qualifying widow or widower) is a rarely used status for a taxpayer whose spouse died in one of the prior two years and who has a dependent child at home. Joint rates are used, but no exemption is claimed for the deceased spouse. In the year the spouse passed away, the surviving spouse may file jointly with the deceased spouse if not remarried by the end of the year. In rare circumstances, for the year of a spouse’s death, the executor of the decedent’s estate may determine that it is better to use the married separate status on the decedent’s final return, which would then also require the surviving spouse to use the married separate status for that year.

·         Adjusted Gross Income (AGI)—AGI is the acronym for adjusted gross income. AGI is generally the sum of a taxpayer’s income less specific subtractions called adjustments (but before the standard or itemized deductions and exemptions). The most common adjustments are job-related moving expenses, penalties paid for early withdrawal from a savings account, and deductions for contributing to an IRA or self-employment retirement plan. Many tax benefits and allowances, such as credits, certain adjustments, and some deductions are limited by a taxpayer’s AGI.

·         Modified AGI (MAGI)—Modified AGI is AGI (described above) adjusted (generally up) by tax-exempt and tax-excludable income. MAGI is a significant term when income thresholds apply to limit various deductions, adjustments, and credits. The definition of MAGI will vary depending on the item that is being limited.

·         Taxable Income—Taxable income is AGI less deductions (either standard or itemized) and exemptions. Your taxable income is what your regular tax is based upon using the tax rate schedule. The IRS publishes tax tables that are based on the tax rate schedules and that simplify tax calculation, but the tables can only be used to look up the tax on taxable income up to $99,999.

·         Marginal Tax Rate (Tax Bracket)—Not all of your income is taxed at the same rate. The amount equal to the sum of your deductions and exemptions is not taxed at all. The next increment is taxed at 10%, then 15%, etc., until you reach the maximum tax rate. When you hear people discussing tax brackets, they are referring to the marginal tax rate. Knowing your marginal rate is important because any increase or decrease in your taxable income will affect your tax at the marginal rate. For example, suppose your marginal rate is 25% and you are able to reduce your income $1,000 by contributing to a deductible retirement plan. You would save $250 in federal tax ($1,000 x 25%). Your marginal tax bracket depends upon your filing status and taxable income. You can find your marginal tax rate using the table below.

Keep in mind when using this table that the marginal rates are step functions and that the taxable incomes shown in the filing-status column are the top value for that marginal rate range.

2013 MARGINAL TAX RATES
TAXABLE INCOME BY FILING STATUS
Marginal Tax Rate	Single	Head of Household	Joint*	Married Filing Separately
10.0%	8,925	12,750	17,850	8,925
15.0%	36,250	48,600	72,500	36,250
25.0%	87,850	125,450	146,400	73,200
28.0%	183,250	203,150	223,050	111,525
33.0%	398,350	398,350	398,350	199,175
35.0%	400,000	425,000	450,000	225,000
39.6%	Over 400,000	Over 425,000	Over 450,000	Over 225,000

      * Also used by taxpayers filing as surviving spouse  

• Taxpayer & Dependent Exemptions—You are allowed to claim a personal exemption for yourself, your spouse (if filing jointly), and each individual who qualifies as your dependent. The amount you are allowed to deduct is adjusted for inflation annually; the amount for 2013 is $3,900.
• Dependents—To qualify as a dependent, an individual must be the taxpayer’s qualified child or pass all five dependency qualifications: the (1) member of the household or relationship test, (2) gross income test, (3) joint return test, (4) citizenship or residency test, and (5) support test. The gross income test limits the amount a dependent can make if he or she is over 18 and does not qualify for an exception for certain full-time students. The support test generally requires that you pay over half of the dependent’s support, although there are special rules for divorced parents and situations where several individuals together provide over half of the support.
• Qualified Child—A qualified child is one who meets the following tests:

(1) has the same principal place of abode as the taxpayer for more than half of the tax year except for temporary absences

(2) is the taxpayer’s son, daughter, stepson, stepdaughter, brother, sister, stepbrother, stepsister, or a descendant of any such individual

(3) is younger than the taxpayer

(4) did not provide over half of his or her own support for the tax year

(5) is under age 19, or under age 24 in the case of a full-time student, or is permanently and totally disabled (at any age)

(6) was unmarried (or if married, either did not file a joint return or filed jointly only as a claim for refund)

• Deductions—Taxpayers can choose to itemize deductions or use the standard deductions. The standard deductions, which are adjusted for inflation annually, are illustrated below for 2013.

Filing Status	Standard Deduction
Single	$6,100
Head of Household	$8,950
Married Filing Jointly	$12,200
Married Filing Separately	$6,100

The standard deduction is increased by multiples of $1,500 for unmarried taxpayers who are over age 64 and/or blind. For married taxpayers, the additional amount is $1,200. The extra standard deduction amount is not allowed for elderly or blind dependents. Those with large deductible expenses can itemize their deductions in lieu of claiming the standard deduction.

Itemized deductions include:

(1) Medical expenses, limited to those that exceed 10% of your AGI for the year (Note: The limitation is 7.5% of AGI for seniors age 65 and older through 2016.)

(2) Taxes consisting primarily of real property taxes, state income (or sales) tax, and personal property taxes

(3) Interest on qualified home debt and investments; the latter is limited to net investment income (i.e., the deductible interest cannot exceed your investment income after deducting investment expenses)

(4) Charitable contributions, generally limited to 50% of your AGI, but in certain circumstances the limit can be as little as 20% or 30% of AGI

(5) Miscellaneous employee business expenses and investment expenses, but only to the extent that they exceed 2% of your AGI

(6) Casualty losses in excess of 10% of your AGI plus $100 per occurrence

(7) Gambling losses to the extent of gambling income, and certain other rarely encountered deductions

·         Alternative Minimum Tax (AMT)—The Alternative Minimum Tax is another way of being taxed that taxpayers frequently overlook. An increasing number of taxpayers are being hit with AMT. The Alternative Minimum Tax (AMT) is a tax that was originally intended to ensure that wealthier taxpayers with large write-offs and tax-sheltered investments pay at least a minimum tax. However, even taxpayers whose only “tax shelter” is having a large number of dependents or paying high state income or property taxes may be affected by the AMT. Your tax must be computed by the regular method and also by the alternative method. The tax that is higher must be paid. The following are some of the more frequently encountered factors and differences that contribute to making the AMT greater than the regular tax.

o    Personal and dependent exemptions are not allowed for the AMT. Therefore, separated or divorced parents should be careful not to claim the exemption if they are subject to the AMT and instead allow the other parent to claim the exemption. This strategy can also be applied to taxpayers who are claiming an exemption under a multiple support agreement.

o    The standard deduction is not allowed for the AMT, and a person subject to the AMT cannot itemize for AMT purposes unless he or she also itemizes for regular tax purposes. Therefore, it is important to make every effort to itemize if subject to the AMT.

o    Itemized deductions:

§  Medical deductions are allowed in excess of 10% of AGI from 2013 through 2016. The amount of deductible medical expenses for regular tax and AMT will be different for seniors, who are allowed to claim medical deductions in excess of 7.5% of AGI for regular tax during this period. For other taxpayers, the medical deductions allowed for regular tax and AMT will be the same.

§  Taxes are not allowed at all for the AMT.

§  Interest in the form of home equity debt interest and interest on debt for non-conventional homes such as motor homes and boats are not allowed as AMT deductions.

§  Miscellaneous deductions subject to the 2% of AGI reduction are not allowed against the AMT.

o    Nontaxable interest from private activity bonds is tax free for regular tax purposes, but some is taxable for the AMT.

o    Statutory stock options (incentive stock options) when exercised produce no income for regular tax purposes. However, the bargain element (difference between grant price and exercise price) is income for AMT purposes in the year the option is exercised.

o     Depletion allowance in excess of a taxpayer’s basis in the property is not allowed for AMT purposes.

A certain amount of income is exempt from the AMT, but the AMT exemptions are phased out for higher-income taxpayers. The amounts shown are for 2013.

AMT EXEMPTIONS & PHASE OUT
Filing Status	Exemption Amount	Income Where Exemption Is Totally Phased Out
Married Filing Jointly	$80,800	$477,100
Married Filing Separate	$40,400	$238,550
Unmarried	$51,900	$323,000

AMT TAX RATES—2013
AMT Taxable Income	Tax Rate
0 – $179,500 (1)	26%
Over $179,500 (1)	28%

 ⁽¹⁾ $89,750 for married taxpayers filing separately

Your tax will be whichever is higher of the tax computed the regular way and the Alternative Minimum Tax. Anticipating when the AMT will affect you is difficult, because it is usually the result of a combination of circumstances. In addition to those items listed above, watch out for transactions involving limited partnerships, depreciation, and business tax credits only allowed against the regular tax. All of these can strongly impact your bottom-line tax and raise a question of possible AMT. Tax Tip: If you were subject to the AMT in the prior year, itemized your deductions on your federal return for the prior year, and had a state tax refund for that year, part or all of your state income tax refund from that year may not be eligible for inclusion in the regular tax computation. To the extent that you received no tax benefit from the state tax deduction because of the AMT, that portion of the refund is not eligible for inclusion in the subsequent year’s income.

·         Tax Credits—Once your tax is computed, tax credits can reduce the tax further. Credits reduce your tax dollar for dollar and are divided into two categories: those that are nonrefundable and can only offset the tax, and those that are refundable. In addition, some credits are not deductible against the AMT, and some credits, when not fully used in a specific tax year, can carry over to succeeding years. Although most credits are a result of some action taken by the taxpayer, there are two commonly encountered credits that are based simply on the number of your dependents or your income. These and a third popular credit are outlined below.

o    Child Tax Credit—The child tax credit is $1,000 per child. If the credit is not entirely used to offset tax, the excess portion of the credit, up to the amount that the taxpayer’s earned income exceeds a threshold ($3,000 for 2011–2017) is refundable. Taxpayers with three or more qualifying dependent children may use an alternate method for figuring the refundable portion of their credit. The credit is allowed against both the regular tax and the AMT for each dependent under age 17. The credit begins to phase out at incomes (MAGI) of $110,000 for married joint filers, $75,000 for single taxpayers, and $55,000 for married individuals filing separate returns. The credit is reduced by $50 for each $1,000 (or fraction of $1,000) of modified AGI over the threshold.

o    Earned Income Credit—This is a refundable credit for a low-income taxpayer with income from working either as an employee or a self-employed individual. The credit is based on earned income, the taxpayer’s AGI, and the number of qualifying children. A taxpayer who has investment income such as interest and dividends in excess of $3,300 (for 2013) is ineligible for this credit. The credit was established as an incentive for individuals to obtain employment. It increases with the amount of earned income until the maximum credit is achieved and then begins to phase out at higher incomes. The table below illustrates the phase-out ranges for the various combinations of filing status and earned income and the maximum credit available.

2013 EIC PHASE-OUT RANGE
Number of Children	Joint Return	Others	Maximum Credit
None	$13,310 – $19,680	$7,970 – $14,340	$487
1	$22,870 – $43,210	$17,530 – $37,870	$3,250
2 3	$22,870 – $48,378 $22,870 – $51,567	$17,530 – $43,038 $17,530 – $46,227	$5,372 $6,044

o    Residential Energy-Efficient Property Credit—This credit is generally for energy-producing systems that harness solar, wind, or geothermal energy, including solar-electric, solar water-heating, fuel-cell, small wind-energy, and geothermal heat-pump systems. These items qualify for a 30% credit with no annual credit limit. Unused residential energy-efficient property credit is generally carried over through 2016.

·         Withholding and Estimated Taxes—Our “pay-as-you-go” tax system requires that you make payments of your tax liability evenly throughout the year. If you don’t, it’s possible that you could owe an underpayment penalty. Some taxpayers meet the “pay-as-you-go” requirements by making quarterly estimated payments. However, when your income is primarily from wages, you usually meet the requirements through wage withholding and rely on your employer’s payroll department to take out the right amount of tax, based on the withholding allowances shown on the Form W-4 that you filed with your employer. To avoid potential underpayment penalties, you are required to deposit by payroll withholding or estimated tax payments an amount equal to the lesser of:

1)    90% of the current year’s tax liability; or

2)    100% of the prior year’s tax liability or, if your AGI exceeds $150,000 ($75,000 for taxpayers filing as married separate), 110% of the prior year’s tax liability.

If you had a significant change in income during the year, we can assist you in projecting your tax liability to maximize the tax benefit and delay paying as much tax as possible before the filing due date.

Please call our office if we can be of assistance with your tax planning needs.

(601) 649-5207

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Selling Your Home

 Article Highlights

• Individuals can exclude up to $250,000 ($500,000 for a married couple filing jointly) of gain from the sale of their primary residence.
• Generally, to qualify for the exclusion, the home must have been owned and used as a primary residence for two of the prior five years.
• Reduced exclusions apply in certain circumstances where the home was owned and used less than the required two years.
• Special rules apply to a home acquired via a tax-deferred exchange that was formerly used as a rental or when a portion of the home was used for business.
• Un-excluded gain is subject to more favorable capital gains tax rates.

During the summer months, many people sell their homes and move to a new location. Many of those individuals will make a profit on the sale and still will not have to pay a single dime of additional income tax to the IRS. If you are in this position, you may find the following information useful.

Generally, a profit is made if the selling price of a home is greater than the price that was paid to purchase the home. That profit, considered a capital gain, is usually subject to income tax. If there is loss, the loss is generally not deductible since the home is personal use property. However, under certain circumstances, the law allows you to exclude all or part of that gain from your income – that is, tax may not have to be paid on the profit.

Individuals may be able to exclude up to $250,000 of home sale capital gain, and married taxpayers filing joint returns may be able to exclude up to $500,000. The exclusion may be claimed each time the main home is sold, but generally not more than once every two years. An unmarried surviving spouse may be able exclude $500,000 if the sale occurs no later than two years after the date of the other spouse’s death.

To qualify, you must meet both the ownership and use tests.

• Ownership Test: During the five-year period ending on the date of the sale, you must have owned the home for at least two years.
• Use Test: During the five-year period ending on the date of the sale, you must have lived in the home as your main home for at least two years.

If you file a joint return with your spouse and both of you meet the use test, you normally will be able to claim the exclusion for married couples even if only one of you meets the ownership test.

If these tests are not met, a reduced amount of the home sale gain may still be excluded. But the home must have been sold for other specific reasons, such as serious health issues, a change in the place of employment, or certain unforeseen circumstances (such as a divorce or legal separation), natural or man-made disasters resulting in a casualty to the home, or an involuntary conversion of the home.

For individuals on qualified official extended duty in the U.S. Armed Services, the Foreign Service, or the intelligence community, the five-year test period may be suspended for up to ten years. Military service is considered qualified extended duty when, for more than 90 days or for an indefinite period, that individual is:

• At a duty station that is at least 50 miles from his or her main home, or
• Residing under government orders in government housing.

If you have more than one home, you can exclude a gain only from the sale of your main home. You must pay tax on the gain from selling any other home. If you have two homes and live in both of them, your main home is ordinarily the one you live in most of the time.

Additional complications may apply if the home was acquired via a tax-deferred exchange, was previously a rental, or was used partially for business.

If you have a gain after applying the allowable exclusion, that gain will be reported on Form 8949 and the gain taxed similar to gain from selling stocks and bonds. If held a year or less, it will be a short-term capital gain taxed at ordinary income tax rates. If held for more than a year, it will be taxed at the more favorable long-term capital gain rate, which varies from zero to 20% (the higher your income for the year, the higher the capital gain rate). If you have capital losses from sales of other property during the year or capital loss carryovers from prior years, they can be used to offset the home gain that exceeds the exclusion amount.

If your modified adjusted gross income for the year exceeds $200,000 ($250,000 for joint filers and $125,000 married individuals filing separately), some portion of the gain will also be subject to the new 3.8% surtax on net investment income that is imposed as part of the Affordable Care Act (the new health care reform law).

Finally, if you purchased your home in 2008, claimed the first-time homebuyer’s credit, and have a gain from selling the home, you may be required to recapture the balance of the un-repaid credit.

Issues connected to selling a home can be complicated. If you have questions related to your specific circumstances, please give our office a call.

(601) 649-5207

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Owner-Only Businesses Should Consider a Solo 401(k) Plan

Article Highlights

•              Solo 401(k) plans allow greater income deferral than most other retirement plans.

•              A Solo 401(k) plan suits self-employed and owner-only corporations.

•              The plan needs to be established prior to year’s end.

•              The plan is generally not beneficial if company has employees other than a spouse.

It goes by many names: Solo 401(k), Mini 401(k), and single-participant 401(k). We will use Solo 401(k) in this article to describe probably the best type of pension plan for owner-only businesses. It provides for larger contributions, including a Roth option for a portion of the contribution, and the ability to borrow funds from the plan at reasonable rates. Consequently, Solo 401(k) plans have become more attractive options than SEP-IRAs, SIMPLE IRAs, or profit-sharing or money purchase plans. In addition, if the plan permits—and most do—assets from other retirement plans can be rolled over into the Solo 401(k) plan.

Generally, Solo 401(k) plans are a natural fit for two categories of people. The first are those who operate a business as an independent contractor, sole proprietor, or owner-only C or S corporation. The second are those who have dual incomes: they are W-2 wage earners as employees of a company that offers a 401(k) plan, but also have consulting income from corporate directorships or freelance work that requires them to file a Schedule C as a sole proprietor. Since the 401(k) contribution limits apply to each individual for the year and not to the individual plans, the taxpayer who has multiple 401(k) plans needs to make sure that no more than the annual limit is contributed to the total combination of plans.

For 2013, the rules limit employer contribution (profit-sharing contribution) to 25% of compensation. The employee can also make salary deferral contributions up to $17,500. Together, these contributions cannot exceed the lesser of $51,000 or 100% of compensation. In addition, if the employee is aged 50 or over, he or she can make an additional catch-up contribution of $5,500. The business owner in these arrangements is considered to be both an employee and an employer.

Example: Susan Lewis, 49, is the sole employee of an incorporated business. Her earned income is $100,000 in 2013. Under the law, Susan can contribute $25,000 to a SEP-IRA ($100,000 × .25), $14,500 ($11,500 plus 3% of $100,000) to a Simple IRA, or $25,000 to a profit-sharing or money purchase plan. On the other hand, she can contribute $42,500 to a Solo 401(k) plan ($25,000 employer contribution plus $17,500 employee deferral), which is still under the $51,000 maximum for the year. If Susan is 50 or over, she can also make a catch-up contribution of $5,500, increasing her 401(k) contribution total to $48,000.

In some cases, 401(k) plan contributions for an unincorporated business may be slightly lower than the above amounts. For unincorporated businesses, compensation is net profit minus half of self-employment taxes minus employer contributions.

Although single-participant 401(k) plans are limited to the business owner and his or her spouse, business owners should note the added benefits of having his or her spouse as the business’s only other employee. Having the spouse on the payroll allows the business owner to shelter some or all of his or her income by having his or her spouse make an elective deferral to a 401(k) plan in addition to the business making a profit-sharing contribution. Although the spouse and the business would be responsible for their respective shares of employment taxes on the salary, combined employer and employee contributions could be up to the lesser of $51,000 (for 2013) or 100% of compensation. This limit applies separately to the business-owner and the spouse, thus allowing a combined total of up to $102,000 (for 2013). In addition, if aged 50 or over, each individual could defer an additional $5,500 each year.

Potential downside: If a business grows and begins to hire employees, the single-participant 401(k) plan must become a full-blown 401(k) plan subject to other, more stringent rules, including discrimination testing, that can serve to limit contributions by highly paid executives. Many providers recommend that businesses with immediate expansion plans not set up one of the Solo 401(k) arrangements.

Caution: If the business owner has other businesses or is part of a controlled group of corporations, partnerships, proprietorships, or affiliated service groups, the employer aggregation rules may apply and the employees of those other businesses may have to be considered for purposes of meeting qualification and minimum coverage requirements for the Solo 401(k).

For additional information about Solo 401(k) plans and how they might fit into your tax strategy and retirement-planning, please give our office a call. If you are considering a Solo 401(k) plan, be aware that the plan must be set up before year’s end. 

(601) 649-5207 

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Give Withholding and Payments a Check-up to Avoid a Tax Surprise

Article Highlights

·         2013 could hold some unpleasant tax surprises because of :

o    Increased long-term capital gains rates.

o    Increased ordinary tax rates.

o    A new 3.8% tax on net investment income.

o    The new additional 0.9% HI (Medicare) payroll and self-employment tax.

o    Life-changing events such as marriage, birth of a child, or new job.

o    One-time increase in income from sales of stock or real estate.

·         Under-withholding and underpaid estimates could cause penalties, but corrective actions before year-end may mitigate the penalties.

2013 will hold some unpleasant tax surprises for many taxpayers simply because of the increased long-term capital gains tax rates, the ordinary income tax rates, and the imposition of two new taxes as part of the Affordable Care Act, including a new 3.8% surtax on net investment income and an additional 0.9% payroll and self-employed health insurance tax.

Other factors can also have an impact on the results of your tax return. These include life events such as marriage, birth, or adoption of a child; divorce or separation; the death of a spouse; a new job; a bonus; or a spouse going to work.

You may have sold a business, real estate, stocks, or other assets that will produce a one-time increase in income. 

So, if you have a substantial increase in tax as the result of any of the above or other events, it may be wise to review your withholding and/or estimated tax payments to ensure you have set aside funds for the increase in taxes and have paid in enough in advance to avoid or minimize an underpayment penalty.

Generally if you have not paid evenly throughout the year withholding and estimated taxes, so that they will equal 90% of your tax liability for the year or 100% of the prior year’s liability (110% if your income is over $150,000), you may be subject to an underpayment penalty for the year. This office can project your 2013 tax liability to prepare you for your tax liability and so you can either adjust your withholding or make estimated tax payments to minimize penalties. If you are already set up to pay estimated tax, revising the remaining payment vouchers may be appropriate.

If a potential large tax liability is discovered early enough, your withholding for the rest of the year can be adjusted. Withholding is treated as deposited ratably over the course of the year even if paid towards the end of the year, which helps mitigate underpayment penalties where you are underpaid in the earlier quarters.

If our office can be of assistance with tax planning, tax projections, or in modifying your withholding and estimated payments, please call for an appointment.

(601) 649-5207

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October Extension Due Date Rapidly Approaching

Article Highlights

• October 15 is the extended due date for filing 2012 federal individual tax returns. 

Late-filing penalty for individual federal returns is 5% of the tax due for each month, or part of a month, for which a return is not filed, up to a maximum of 25% of the tax due. A separate penalty applies for filing a state return late.

If you could not complete your 2012 tax return by the normal April filing due date, and are now on extension, that extension expires on October 15, 2013, and there are no additional extensions. Failure to file before the extension period runs out can subject you to late-filing penalties.

There are no additional extensions, so if you still do not or will not have all of the information needed to complete your return by the extended due date, please call the office so that we can explore your options for meeting your October 15 filing deadline.

If you are waiting for a K-1 from a partnership, S-corporation, or fiduciary return, the extended deadline for those returns was September 16. So, if you have not received that information yet, you should probably make inquiries. 

Late-filed individual federal returns are subject to a penalty of 5% of the tax due for each month, or part of a month, for which a return is not filed, up to a maximum of 25% of the tax due. If you are required to file a state return, and do not do so, the state will also charge a late-file penalty.

If our office is waiting for some missing information to complete your return, we will need that information at least a week before the October 15 due date. Please call our office immediately if you anticipate complications related to providing the needed information, so that a course of action may be determined for avoiding the potential penalties.

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October 2013 Due Dates

October 2013 Individual Due Dates

October 10 - Report Tips to Employer

If you are an employee who works for tips and received more than $20 in tips during September, you are required to report them to your employer on IRS Form 4070 no later than October 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.

October 15 - Individuals

If you have an automatic 6-month extension to file your income tax return for 2012, file Form 1040, 1040A, or 1040EZ and pay any tax, interest, and penalties due.

October 15 -  SEP IRA & Keogh Contributions

Last day to contribute to SEP or Keogh retirement plan for calendar year 2012 if tax return is on extension through October 15.

October 2013 Business Due Dates

October 15 -  Electing Large Partnerships

File a 2012 calendar year return (Form 1065-B). This due date applies only if you were given an additional 6-month extension. March 15 was the due date for furnishing Schedules K-1 or substitute Schedule K-1 to the partners.

October 15 - Social Security, Medicare and withheld income tax

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

October 15 - Nonpayroll Withholding

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

October 31 - Social Security, Medicare and Withheld Income Tax

File Form 941 for the third quarter of 2013. Deposit or pay any undeposited tax under the accuracy of deposit rules. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the quarter in full and on time, you have until November 12 to file the return.

October 31 - Certain Small Employers

Deposit any undeposited tax if your tax liability is $2,500 or more for 2013 but less than $2,500 for the third quarter.

October 31 - Federal Unemployment Tax

 Deposit the tax owed through September if more than $500.

If you need assistance or have any questions about these due dates please call our office.

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Don’t Overlook the Credit for Small Employer Health Insurance Premiums

The tax law provides a credit for small business employers in 2010, 2011, 2012, and 2013 that pay the health insurance premiums for their low- to moderate-income workers.  This refundable credit can be as much as 35% of the insurance premiums paid by the employer. 

To qualify for the credit, the employer can’t have more than 25 full-time equivalent employees, and the average wage of the employees cannot exceed $50,000 for the year.  The 25 full-time equivalent employee limit is computed by taking into account both full-time and part-time employees for the year using a formula.

To see if your firm may qualify for the credit, complete the two worksheets below¾the results at lines 6 and 9 will tell you if your firm is under the maximum full-time equivalent employee and average wage limitations.  

Determine the Number of Full-Time Equivalent Employees:
1. Enter the number of employees who worked 2,080 hours or more during the year
2. Multiply line 1 by 2,080
3. Enter the total hours worked by all employees who worked less than 2,080 hours during the year
4. Enter the total of lines 2 and 3
5. Divide the result on line 4 by 2,080
6. Number of full-time equivalent employees (round line 5 down to the next    whole number, unless the number is less than one, in which case enter 1.
If line 6 is greater than 25, stop¾your firm does not qualify for this credit.
Determine the Average Annual Wage:
7. Enter the total of all wages paid to employees during the tax year
8. Divide line 7 by the number of full-time equivalent employees (line 6)
9. Average annual wage (round amount from line 8 down to the next whole $1,000)

If the amount on line 9 is $50,000 or less, you may qualify for the credit.  Besides meeting the limits of lines 6 and 9, to qualify for the credit an employer has to contribute at least 50% of the premiums for the employees’ health insurance coverage on a uniform basis. However, for tax years beginning in 2010 only, an employer can meet this requirement even if it pays differing percentages of different employees’ premiums as long as all employer payments are at least 50% of each employee’s premium based on single (employee-only) coverage.

The amount of the credit gradually phases out if the number of full-time equivalent employees exceeds ten or if the average annual wage of the employees exceeds $25,000. Under the phase-out, the full amount of the credit is available only to an employer with ten or fewer full-time equivalent employees and whose employees have average annual wages of less than $25,000.

Please give our office a call if you have questions related to this credit or determining whether your firm can benefit from claiming the credit. 

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Preparing for the New Surtax

As part of the Affordable Care Act (the new health care legislation), a new tax kicks in this year. The official name of this tax is the Unearned Income Medicare Contribution Tax, and even though the name implies it is a contribution, don’t get the idea that it is voluntary or that you can deduct it as a charitable contribution. It is actually 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, stocks, or other investments.

The surtax is 3.8% on whichever is less: your net investment income or the excess of your modified adjusted gross income (MAGI) over a threshold based on your filing status. Net investment income is your investment income reduced by investment expenses; MAGI is your regular AGI increased by income excluded for working out of the country.

The filing status threshold amounts are:   

• $250,000 for married taxpayers filing jointly and surviving spouses.
• $125,000 for married taxpayers filing separately.
• $200,000 for single and head-of-household filers.

Example: A single taxpayer has net investment income of $100,000 and MAGI of $220,000. The taxpayer would pay a Medicare contribution tax only on the $20,000 amount by which his MAGI exceeds his threshold amount of $200,000, because that is less than his net investment income of $100,000. Thus, the taxpayer’s Medicare contribution tax would be $760 ($20,000 × 3.8%).

Investment income includes: 

• Interest, dividends, annuities (but not distributions from IRAs or qualified retirement plans), and royalties,
• Rents (other than derived from a trade or business), 
• Capital gains (other than derived from a trade or business),
• Home-sale gain in excess of the allowable home-gain exclusion,
• A child’s investment income in excess of the excludable threshold if, when eligible, the parent elects to include the child’s investment income on the parent’s return, 
• 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.

Planning Note: For surtax purposes, gross income doesn’t include interest on tax-exempt bonds. Thus, one can avoid or reduce the net investment income surtax by investing in tax-exempt bonds.  

Investment expenses include:

• Investment interest expense, 
• Investment advisory and brokerage fees,
• Expenses related to rental and royalty income, and
• State and local income taxes properly allocable to items included in Net Investment Income.

Do you think you will never get hit with this tax because your income is way under the threshold amounts? Don’t be so sure. When you sell your home, the gain is a capital gain, and to the extent that the gain is not excludable using the home-gain exclusion, it will add to your income and possibly push you above the taxation thresholds. And, since capital gains are investment income, you might be in for a surprise. The same holds true for gains from selling stock, a second home, or a rental. So when planning to sell a capital asset, be sure to consider the impact of this new surtax.

The surtax also applies to the undistributed net investment income of trusts and estates, and there are special rules applying to the sale of partnership and Sub-S Corporation interests.

Example: A taxpayer has owned a residential rental property for a number of years, planning to use the rental’s increased value to help fund his retirement. The taxpayer normally has income well below the threshold for this new tax. The taxpayer sells the rental and has a substantial gain. The gain from the rental sale gives the taxpayer a one-time windfall that pushes his income above the threshold for the new tax, and he ends up having to pay the regular capital gains tax plus an additional 3.8% tax on the appreciation that is attributable to the increase in value that occurred over several years.     

If this surtax will apply to you in 2013, you may need to increase your income tax withholding or estimated tax payments to cover the additional tax so you can avoid or minimize an underpayment of estimated tax penalty when you file your 2013 return.

Example: A taxpayer has owned a residential rental property for a number of years, planning to use the rental’s increased value to help fund his retirement. The taxpayer normally has income well below the threshold for this new tax. The taxpayer sells the rental and has a substantial gain. The gain from the rental sale gives the taxpayer a one-time windfall that pushes his income above the threshold for the new tax, and he ends up having to pay the regular capital gains tax plus an additional 3.8% tax on the appreciation that is attributable to the increase in value that occurred over several years.     

If your income normally exceeds the threshold for this new tax, or you have or are contemplating a large capital gain and would like to explore options to mitigate the impact of the tax, please give our office a call.

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Back-to-School Tax Tips for Students and Parents

Article Highlights

• Sec. 529 plans allow very large sums of money to be put away for a child’s college education with the earnings accumulating as tax-deferred and tax-free, if used for qualified college education expenses.
• Coverdell Education Savings Accounts allow $2,000 a year to be set aside for a child’s education. Earnings are tax-deferred and tax-free if used for qualified education expenses. Coverdell funds can be used for kindergarten through college education expenses.
• The American Opportunity education credit provides a credit of up to $2,500 per student per year, covering the first four years of qualified post-secondary education.
• The Lifetime Learning credit provides up to 20% of the first $10,000 of qualifying higher education expenses per family per year.
• A deduction from gross income of up to $2,000 or $4,000, depending on income, for qualifying tuition and fees may be claimed for 2013, but the same expenses cannot be used for this deduction and education credits.
• Up to $2,500 can be deducted per year for qualified education loan interest.

Going to college can be a stressful time for students and parents. In recent years, Congress has provided a variety of tax incentives to help defray the cost of education. Some require long-term planning to become beneficial, while others provide current tax deductions or credits. The benefits may even cover vocational schools.

If your child is below college age, there are tax-advantaged plans that allow you to save for the cost of college. Although providing no tax benefit for contributions to the plans, they do provide tax-free accumulation; so the earlier they are established, the more you benefit from them.

• Section 529 Plans—Section 529 Plans (named after the section of the IRS Code that created them) are plans established to help families save and pay for college in a tax-advantaged way and are available to everyone, regardless  of income. These state-sponsored plans allow you to gift large sums of money for a family member’s college education while maintaining control of the funds. The earnings from these accounts grow tax-deferred and are tax-free, if used to pay for qualified higher education expenses. They can be used as an estate-planning tool as well, providing a means to transfer large amounts of money without gift tax. With all these tax benefits, 529 Plans are an excellent vehicle for college funding. Section 529 Plans come in two types, allowing you to either save funds in a tax-free account to be used later for higher education costs, or to prepay tuition for qualified universities. For 2013, you can contribute $14,000 without gift tax implications (or $28,000 for married couples who agree to split their gift). The annual amount is subject to inflation-adjustment. There is also a special gift provision allowing the donor to prepay five years of gifts up front without gift tax.
• Coverdell Education Savings Account—These accounts are actually education trusts that allow nondeductible contributions to be invested for a child’s education. Tax on earnings from these accounts is deferred until the funds are withdrawn, and if used for qualified education purposes, the entire withdrawal can be tax-free. Qualified use of these funds includes elementary and secondary education expenses in addition to post-secondary schools (colleges). This is the only one of the educational tax benefits that allows tax-free use of the funds for below college-level expenses. A total of $2,000 per year can be contributed for each beneficiary under the age of 18. The ability to contribute to these plans phases out when the modified adjusted gross income is between $190,000 and $220,000 for married taxpayers filing jointly, and between $95,000 and $110,000 for all others.
• Education Tax Credits—Two tax credits, the American Opportunity Credit (partially refundable) and the Lifetime Learning Credit (nonrefundable), are available for qualified post-secondary education expenses for a taxpayer, spouse, and eligible dependents. Both credits will reduce one’s tax liability dollar for dollar until the tax reaches zero. The credit is not allowed for taxpayers who file Married Separate returns.
• The American Opportunity Credit—is a credit of up to $2,500 per student per year, covering the first four years of qualified post-secondary education. The credit is 100% of the first $2,000 of qualifying expenses plus 25% of the next $2,000 for a student attending college on at least a half-time basis. Forty percent of the American Opportunity credit is refundable (if the tax liability is reduced to zero.) This credit phases out for joint filing taxpayers with modified adjusted gross income between $160,000 and $180,000, and between $80,000 and $90,000 for others.   
• The Lifetime Learning Credit—is a credit of up to 20% of the first $10,000 of qualifying higher education expenses. Unlike the American Opportunity Credit, which is on a per-student basis, this credit is per taxpayer. In addition to post-secondary education, the Lifetime Credit applies to any course of instruction at an eligible institution taken to acquire or improve job skills. This credit phases out for joint filing taxpayers with modified adjusted gross income between $107,000 and $127,000, and between $53,000 and $63,000 for others. The credit is not allowed for taxpayers who file Married Separate returns.  

Qualifying expenses for these credits are generally limited to tuition. However, student activity fees and fees for course-related books, supplies, and equipment qualify if they must be paid directly to the educational institution for the enrollment or attendance of the student.

You may qualify for this credit even if you did not pay the tuition. If a third party (someone other than the taxpayer or a claimed dependent) makes a payment directly to an eligible educational institution for a student’s qualified tuition and related expenses, the student would be treated as having received the payment from the third party, and, in turn, pay the qualified tuition and related expenses. Furthermore, qualified tuition and related expenses paid by a student would be treated as paid by the taxpayer if the student is a claimed dependent of the taxpayer.

• Tuition and Fees Deduction—Up to $4,000 of qualified tuition and related expenses for higher education may be deducted as a direct reduction of income without having to itemize deductions. If your modified adjusted gross income (MAGI) is $65,000 or less ($130,000 or less if filing a joint return), the deduction is capped at $4,000, but if MAGI exceeds these amounts and is no more than $80,000 ($160,000 joint), the deduction is limited to a maximum of $2,000. If your MAGI is above $80,000 ($160,000 joint), or you file as Married Separate, no deduction is allowed. The same expenses cannot be used to qualify for one of the education credits and the tuition and fees deduction, and no deduction is allowed if the tuition and related expenses were paid with tax-free distributions of earnings from a Sec. 529 plan or a Coverdell education savings account. Unless extended by Congress, 2013 will be the last year that this deduction may be claimed.

• Education Loan Interest—You can deduct qualified interest of $2,500 per year in computing AGI. This is not limited to government student loans and this could include home equity loans, credit card debt, etc., if the debt was incurred solely to pay for qualified higher education expenses. For 2013, this deduction phases out for married taxpayers with an AGI between $125,000 and $155,000 and for unmarried taxpayers between $60,000 and $75,000. This deduction is not allowed for taxpayers who file married separate returns.

We all know that a child’s success in life has a great deal to do with the education they receive. You cannot start the planning process too early. Please call our office if you would like assistance in planning for your children’s future education.

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ACA Employer Letter (Employee Notification) Requirement

Article Highlights

•              Employers must give employees health care notification.

•              Affects employers with one or more employees and a gross income of $500,000 or more.

•              Notices due October 1, 2013.

•              New Employees must be notified within 14 days.

Beginning Oct. 1, any business with at least one employee and $500,000 in annual revenue must notify all employees by letter about the Affordable Care Act’s health care exchanges. The requirement applies to any business regulated under the Fair Labor Standards Act (FLSA), regardless of size. Going forward, letters are to be distributed to any new hires within 14 days of their starting date, according to the Department of Labor.

The Patient Protection and Affordable Care Act has a general $100-per-day penalty for non-compliance. Since this requirement is in the FLSA, concerns were raised in the business community that the $100-per-day penalty would apply to businesses that did not comply with the notification requirements.

On September 12, 2013, the Small Business Administration (sba.gov) posted a blog called “Myth #3: Business Owners Will Be Fined if They Don’t Notify Their Employees about the New Health Insurance Marketplace.” The article clarifies the policy, stating: “If your company is covered by the FLSA, you must provide a written notice to your employees about the Health Insurance Marketplace by October 1, 2013. However, there is no fine or penalty under the law for failing to provide the notice.”

The Department of Labor provides model notices for employers:

• Employers with plans: http://www.dol.gov/ebsa/pdf/FLSAwithplans.pdf
• Employers without plans: http://www.dol.gov/ebsa/pdf/FLSAwithoutplans.pdf

If you have questions, please give our office a call.

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