Capital Gains Strategies

One of the greatest benefits of the tax code is the special tax rates that currently apply to gain recognized from the sale of capital assets held for more than a year (long-term). The special tax rates apply to virtually all capital assets including land, improved real estate, your main and vacation homes, and business assets in excess of the accumulated depreciation previously deducted. These special long-term capital gains (LTCG) rates for 2010 are 0% (yes that is correct - zero) to the extent your regular tax rate is in the 15% or 10% brackets and 15% for most other capital gains. These rates also apply for the alternative minimum tax. The following are some issues and strategies that you may find of interest before year's end.

Historically, the end of the year has 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 gains from "winners," and where possible, generate the maximum allowable $3,000 ($1,500 for married taxpayers filing separately) capital loss for the year.

Assets that are not held long-term, referred to as short-term capital gains (STCG), do not receive benefits of the special rates afforded long-term capital gains. Taxpayers achieve a better overall tax benefit if they can arrange their transactions so as to offset short-term capital gains with long-term capital losses.

For those who would benefit from the zero LTCG rate in 2010, it may be appropriate to sell assets and create long-term capital gains to the extent those gains would be taxed at the zero rate. However, this is a balancing act since LTCG also increases your income, which may push you into higher tax brackets. Of course, you can also use losses to offset the gains, and contrary to conventional strategy, you should only have enough losses to keep the gain within the zero tax rates. If your income is too high to take advantage of the zero tax rates, then continue to employ the conventional strategies discussed above.

If you exercised incentive (qualified) stock options with your employer this year and you are still holding the stock, selling the stock before year's end to avoid phantom income created by the alternative minimum tax may be appropriate.

If you are planning substantial gifts to charity or to relatives and have capital assets that have appreciated in value, gifting the appreciated assets rather than cash may be beneficial.

The actions mentioned above may have additional factors that must be considered and require careful planning. You are encouraged to consult with this office before acting on any of the suggested strategies.

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Rental Owners Need to Prepare for the New 2011 Reporting Requirement

If you are a rental owner and during 2011 make payments of $600 or more to a service provider (such as a plumber, painter, or accountant) in the course of earning rental income, the 2010 Small Business Jobs Act says that you are required to provide an information return (typically Form 1099-MISC) to IRS and to the service provider. In order to do that, you must obtain the payee's name, SSN and contact information before making payment. The IRS provides Form W-9 for that purpose.

There is a "Catch-22" you need to watch out for. Suppose you call a plumber and pay him $400 for a service call at your rental property and don't bother to have him complete and sign a W-9 since the amount is under $600. Later in the year, you need him again and pay him another $400 for the second service call at the rental. Again, you fail to obtain the completed W-9. Now you have a 1099 filing requirement but do not have the information you need to file the information returns in 2012. If the plumber can't be found, then you are left holding the bag. The moral of this story is to always collect a completed W-9 from the payee before paying him!

What happens if you don't meet your filing obligation? Well, there are monetary penalties! And as part of the 2010 Small Business Act, the penalties were doubled for information returns required to be filed after 2010. So if you are 30 days late filing the information return with the IRS or furnishing a copy to the payee, you are subject to a $30 per payee penalty. If the returns are more than 30 days late but filed by August 1, the penalty per payee is $60; if filed after August 1, the penalty jumps to $100 per payee.

The penalties can be substantial and you are cautioned to establish a procedure for obtaining W-9s from your service providers before the beginning of 2011. Note: Payments to incorporated businesses and those made for the purchase of merchandise are not included in these requirements until 2012.

When filing 1099s, your SSN or an Employee ID Number (EIN) must be included on the form provided to each payee. It may be in your best interest to file for an EIN so that individuals who are issued 1099s don't end up with your SSN.

Please call our office if you need assistance.

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New Roth IRA Opportunities

2010 is the first year in which taxpayers—including married taxpayers filing separately—are able to convert funds in regular IRAs (including SEP and Simple IRAs) to Roth IRAs, regardless of income level. This can provide a significant opportunity for certain taxpayers.

There are several advantages to a Roth IRA - All future earnings and distributions at retirement generally will be tax-free, and Roth IRAs are not subject to the required minimum distribution rules. Because distributions from Roth IRAs are tax-free (if they are qualified distributions), they may keep a taxpayer from being taxed in a higher tax bracket than would otherwise apply if he were withdrawing taxable distributions. Roth IRAs don't enter into the calculation of tax owed on Social Security payments and have no effect on AGI-based deductions. What's more, the benefits flow through to beneficiaries of inherited Roth IRA accounts, who also can make tax-free withdrawals from such accounts (beneficiaries, however, are subject to the same annual post-death minimum distribution rules that apply to beneficiaries of regular IRAs).

Conversion downside – The conversions are taxable, except for previously non-deductible amounts, but they are not subject to the 10% premature distribution tax.

Should you make an IRA-to-Roth IRA conversion? Generally, taxpayers with the following tax profiles should consider making a conversion:

• Those who still have a number of years to go before retirement and time to recoup conversion tax dollars.
  
• Those in a lower-than-normal tax bracket in the year of conversion.
  
• Those who anticipate being taxed in a higher bracket in the future.
  
• Those who can pay the tax on the conversion from funds other than non-taxed retirement funds.
  

Complicating factor for 2010 conversions – A unique income inclusion rule will apply for IRA-to-Roth-IRA conversions occurring in 2010. Unless a taxpayer elects otherwise, none of the gross income from the conversion is included in income in 2010; half of the income resulting from the conversion will be includible in gross income in 2011 and the other half in 2012. This requires some careful planning since it is anticipated that taxes will rise in future years.

Additional items to take into consideration:

• It might be appropriate for you to design your own custom conversion plan over a number of years rather than convert everything at once.
  
• Where does the money to pay the conversion tax come from? Generally, it must be from separate funds. If it is taken from the IRA being converted, then for individuals under age 59½, the funds withdrawn to pay the tax will also be subject to the 10% early distribution penalty in addition to being taxed.
  
• Unlike conversions, annual contributions to Roth IRAs are not allowed for certain higher-income taxpayers. However, that problem could be circumvented by contributing to a non-deductible traditional IRA and then making a conversion to a Roth IRA in a subsequent year.
  
• If the traditional IRA being converted consists of assets such as stocks and mutual funds that could decline in value after the conversion, it may be appropriate to apply for an automatic six-month extension to file the conversion year's return. By waiting to file until the extended due date (October 15 for most individuals), the taxpayer has an opportunity to compare the account's market value at that time to what it was when the conversion was made. If the value has dropped significantly, the taxpayer may elect to undo the conversion (called a "recharacterization"), provided certain requirements are met, and avoid paying tax on the higher value. After a specified waiting period, a reconversion can be made.
  

Conversions can be tricky! If you are considering a conversion, please call for an appointment so this office can help you properly analyze your conversion and contribution options.

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Beware of a New Fraud Risk!

There is a fraud risk related to the Electronic Federal Tax Payment System (EFTPS) that you need to be aware of.

Always remember that the IRS does not initiate taxpayer contact by e-mail. Therefore, if you receive an e-mail that appears to be from a tax agency telling you that your federal electronic funds transfer (EFT) payment did not go through, it is part of a phishing scheme and you should not respond to it. The perpetrators of this scheme have duplicated the IRS's EFTPS logo and other characteristics of that system in an attempt to convince taxpayers that it is an official e-mail from the IRS. It is not!

If you receive a message claiming to be from the IRS or EFTPS, take the following steps:

1. Do not reply to the sender, access links on the site, or submit any information to them.

2. Forward the message as-is immediately to IRS at phishing@irs.gov.

3. Visit the IRS website to find out how to report and identify phishing, e-mail scams and bogus IRS websites.

4. If you receive a suspicious e-mail or discover a website posing as the IRS, please forward the e-mail or URL information to the IRS at phishing@irs.gov.

5. EFTPS is a tax payment system provided free by the U.S. Department of Treasury.

Whenever you receive a communication from the IRS, it is generally good practice to contact our office before responding.

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Tax Rumors Abound

There are two false tax rumors that have been circulating around and troubling clients. To set the record straight, a brief explanation of both rumors is provided below.

False Rumor #1 – "Employer-paid health insurance benefits will be taxable in 2011."

Not true! Starting in 2011, the amount of employer-paid healthcare benefits was to be included on the W-2 as an information entry, but is not included in the taxable wages on the W-2. Many sources failed to properly analyze this requirement and reported that the benefits would become taxable in 2011.

False Rumor #2 – "Home sales will be subject to a sales tax."

Not true! This rumor came about because of a 3.8% surtax, beginning in 2013, on net investment income of higher-income taxpayers - generally those with an AGI in excess of $200,000 ($250,000 for married taxpayers filing jointly).

Generally, investment income is, as the name implies, income from investments (such as interest, dividends and capital gains). Net investment income is investment income less certain deductible investment expenses.

Gain from the sale of a home is a capital gain and included in net investment income and, as a result, could be subject to the 3.8% surtax on the profit but not the sales price. In addition, for a home used by a taxpayer for 2 of the prior 5 years preceding the sale, the taxpayer can exclude up to $250,000 ($500,000 for a qualifying married couple) of the gain from the sale. Thus, only the excess above the home gain exclusion would be subject to the surtax.

Bottom line, you could get hit by this surtax if your home sale profits exceed the exclusion and you are a higher-income taxpayer - but it is not a sales tax based on the sales price of the home.

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

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Health Care Professionals Working in Underserved Areas May Qualify for Special Benefit

Under the Affordable Care Act, health care professionals who received student loan relief under state programs that reward those who work in underserved communities may qualify for refunds on their 2009 federal income tax returns, as well as an annual tax cut going forward.

The Affordable Care Act included a change in the law, effective in 2009, that expands a tax exclusion for amounts received by health professionals under loan repayment and forgiveness programs. Prior to the new law, only amounts received under the National Health Service Corps Loan Repayment Program or certain state loan repayment programs eligible for funding under the Public Health Service Act qualified for a tax exclusion.

The Affordable Care Act expands this tax exclusion to include any state loan repayment or loan forgiveness programs intended to increase the availability of health care services in underserved areas or health professional shortage areas and makes this exclusion retroactive to the 2009 tax year.

Health care professionals participating in these programs who have reported income from repaid or forgiven loan amounts on their 2009 returns, possibly after receiving a Form W-2, Wage and Tax Statement, or Form 1099, may be due refunds. Those who believe they qualify for this relief may want to consult their state loan program offices to determine whether the program is covered by the new law.

Health care professionals who have not yet filed for 2009 need not report eligible loan repayment or forgiveness amounts when they file. Those who have already filed may exclude eligible amounts by filing an amended tax return.

Individuals filing an amended return to claim this exclusion should write "Excluded student loan amount under 2010 Health Care Act" in the Explanation of Changes box.

Health care professionals may request an employer or other issuer to provide a Form W-2c, Corrected Wage and Tax Statement, or 1099 and may attach the corrected form to the amended return. However, the amended return may be filed without attaching a corrected form.

An individual whose employer withheld and paid taxes under the Federal Insurance Contributions Act (FICA) on payments covered under the new exclusion may request that the employer seek a refund of withheld FICA on the employee's behalf. And because employers also pay a portion of the FICA tax, the employer also may also be entitled to a refund.

To obtain a refund, an employer should file a separate amended Employer's Quarterly Federal Tax Return or Claim for Refund (Form 941-X) for each Form 941, Employer's Quarterly Federal Tax Return, which needs to be corrected. An employer filing a Form 941-X is also required to file a Form W-2c for each employee who benefits from the exclusion.

If you need assistance amending either an individual return or an employer payroll return, please give our office a call.

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