Can You Guess the Six 'Most-Hated Taxes' in America?
Few people are fond of taxes, but some taxes are more despised than others. While
Hollywood is holding various award ceremonies (Grammys, Golden Globes, Oscars, etc.), we're
conducting an awards event of our own. Here are six worthy candidates for the "most-hated
taxes" award in America.
1. Forced Taxes on Retirement Account Withdrawals
Do you have money in an IRA or 401(k) account? Once you turn age 70 1/2, you must
start taking annual required minimum distributions (RMDs) or face a steep penalty. Guess what?
Those required withdrawals are taxable, which is why Congress dreamed up the rules in the first
place. The government wants to get its hands on some of your retirement account money
sooner rather than later.
What if you don't want to take the distributions and pay the tax because you don't need the
money and would rather save it for later in your retirement? Sorry, you don't have a choice.
2. The Alternative Minimum Tax
The original reason for the alternative minimum tax (AMT) was to ensure that the wealthiest
individuals who take advantage of multiple tax breaks would still have to pay some federal
income tax each year. The unfortunate reality today is that upper-middle-income individuals who
pay relatively high state and local taxes and have spouses and kids are the most likely AMT
victims.
Tax Code Complexity:
Could it Lead to Reform?
Think the Internal Revenue Code is too complicated?
You're not alone. The tax writing committee for the
U.S. House of Representatives released a video in
mid-January arguing the tax code is too complex,
confusing and costly.
The video, created by the House Ways and Means
Committee, notes "there have been more than 4,400
changes to the tax code in the last 10 years -- that
adds up to more than one per day."
The video suggests taking three steps:
1. Make the tax code simpler and fairer. By getting rid
of the "junk," the video states, the code can be
reduced in size by 25 percent.
2. Make tax law more efficient "by getting rid of special
interest handouts and lowering tax rates across the
AMT Basics: Think of the AMT
as a separate tax system with a
board."
resemblance to the regular
federal income tax system. One
3. Make the tax code accountable to taxpayers.
difference is the AMT system
taxes certain types of income
that are tax-free under the
regular tax system and disallows some regular tax deductions.
Second, the AMT rate ranges from 26 percent to 28 percent. Regular tax rates range from 10
percent to 39.6 percent. Finally, you're theoretically entitled to a relatively generous AMT
exemption, which is equivalent to a deduction, but the exemption is phased out at upper-middleincome levels. If your AMT bill exceeds your regular tax bill, you must pay the higher AMT
amount.
Interacting factors make it difficult to pinpoint precisely who will be hit by the AMT. But here are
the biggest danger signs of AMT exposure.
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Your gross income is high enough (say $250,000 or higher) that a large part, or all, of
your AMT exemption is phased-out.
You have relatively large deductions for state and local income and property taxes under
the regular tax rules (say $20,000 and up). These deductions are disallowed under AMT
rules.
You have a spouse and several children, which translates into four or more personal
and dependent exemption deductions under the regular tax rules. These deductions
($3,950 each for 2014 and $3,900 for 2013) are disallowed under the AMT rules.
You exercised one or more in-the-money incentive stock options (ISOs). The "bargain
element" (the difference between the market value of the shares on the exercise date
and the exercise price) does not count as income under the regular tax rules. But it does
count as income under AMT rules and can throw you into the AMT zone.
Why Upper-Middle-Income Folks Are the Most Likely Victims
Under our current federal income tax system, the AMT is usually not a factor for individuals with
really high incomes (say $750,000 or higher) for two main reasons.
First their marginal regular federal income rate will be 39.6 percent while the maximum AMT
rate is "only" 28 percent. So folks with really high incomes are less likely to have an AMT bill that
is higher than their regular federal income tax bill. In contrast, folks in the upper-middle-income
zone may have enough regular tax deductions that their average regular tax rate is lower than
the 28 percent maximum AMT rate. Those folks are likely to owe the AMT.
Second, many tax breaks for folks with really high incomes are already cut back under the
regular tax rules before even getting to the AMT calculation. For example, if your income
exceeds certain limits, you'll run into regular tax phase-out rules that chip away or eliminate your
personal exemptions, your biggest itemized deductions, and your tax credits. So you may have
little or nothing left to lose under the AMT rules. High-powered executives are also less likely to
receive incentive stock options (they usually get restricted stock grants or nonqualified options
instead). In contrast, folks in the upper-middle-income zone often have lots to lose, such as
significant deductions that are allowed for regular tax purposes but disallowed under the AMT
rules. And they are more likely to receive incentive stock options. As a result, they are more
likely to wind up owing the AMT.
3. The Social Security Tax
You may not hear that much griping about the Social Security tax. That's strange because it's
just as expensive as the federal income tax for many folks, especially the self-employed. Plus, it
has serious fairness issues.
Social Security tax basics. For employees, wages are hit with the 12.4 percent Social Security
tax up to the annual wage ceiling. Half the Social Security tax (6.2 percent) is withheld from
employees' paychecks. The other half (also 6.2 percent) is paid by the employer, so employees
never actually see it. Unless you understand how the tax works and closely examine your pay
stubs, you may be blissfully unaware of how much the Social Security tax actually costs. The
Social Security tax wage ceiling for 2014 is $117,000 (up from $113,700 for 2013). If your wages
met or exceeded the 2013 ceiling, the Social Security tax hit on last year's wages was a
whopping $14,099 (12.4 percent times $113,700).
While many employees may be in the dark about the magnitude of the tax, because they only
pay half the bill, self-employed folks (sole proprietors, partners, and LLC members) know the full
story. That's because self-employed people must pay the entire 12.4 percent Social Security tax
out of their own pockets, based on their net self-employment income.
Reasons for Hate
Disconnect between the Tax and Benefits. While the Social Security tax ceiling increased by
2.9 percent from 2013 to 2014 (from $113,700 to $117,000), Social Security benefits only
increased by 1.5 percent. This disconnect has occurred in quite a few recent years.
Below are the Social Security Administration's latest projections (issued in June of 2013) for the
Social Security tax ceilings for 2015 and beyond. However, the actual ceilings will probably be
higher based on the estimate for 2014 compared with the actual amounts. Do you think Social
Security benefits will rise at the same rate?
Year
Projected Social Security Tax Ceiling
2015
$118,500
2016
$123,600
2017
$130,500
2018
$137,700
2019
$144,900
2020
$152,100
2021
$159,000
2022
$165,600
Insolvency Is Looming. Some people think the government has accounts with their names on
them to hold money to pay for their future Social Security benefits. They believe that's where the
Social Security taxes on people's wages and self-employment income goes. Sadly, this is not
the case. There are no individual accounts. All you actually have is a non-binding promise from
the government that you will receive benefits. Meanwhile, the Social Security Administration's
most recent report on the system's financial condition (dated May 31, 2013) projects insolvency
in 2033. In that year, the program is only expected to have enough revenue from the Social
Security tax pay about 77 percent of the promised benefits, according to a recent Congressional
Research Service study.
4. The Tax on Social Security Benefits
When you start receiving Social Security benefits, you will discover the sad truth that between 50
and 85 percent of your payments might get hit with federal income tax (the taxable percentage
goes up with your income). That's a rip-off for two reasons.
As explained earlier, you already paid Social Security tax in the form of withholding from your
salary or self-employment tax. So now you are paying income tax on benefits that are based on
a tax you already paid years ago. Even worse, you already paid federal income tax on those
Social Security taxes years ago, because they were included as part of your taxable salary or as
part of your self-employment income.
To sum up:
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You already paid Social Security tax over the years.
You already paid federal income tax on those Social Security tax bills, and
Now you must pay federal income tax on a big chunk of your Social Security benefits.
That's double taxation, or even triple taxation depending on how you look at it. Thankfully,
retirees who are at very low income levels don't have to pay any federal income tax on their
Social Security benefits, but everybody else get socked. Is this unfair? Of course! But the
government wants the revenue stream.
5. Disguised Taxes in the Form of Phase-Out Rules
One of the tricks of politicians is to create a tax break, bask in the favorable publicity, and then
take away the benefit from those whose income is deemed to be "too high" to claim it. For
example, personal and dependent exemption deductions, the most popular itemized deductions,
the child tax credit, the higher-education tax credits, and many other tax breaks are subject to
phase-out rules that reduce or completely eliminate them as your income goes up. In effect,
these phase-outs are disguised tax rate increases -- although you won't hear Congress describe
them that way.
6. The Federal Estate Tax
Many people believe the estate tax is unfair because it amounts to double taxation on wealth
that was already hit with income tax during the deceased person's life. (However, some estates
contain assets with unrealized capital gains that have not been taxed before death.)
How it works. Your taxable estate is your gross estate minus allowable deductions. Your gross
estate includes cash and property (real estate, stocks, bonds, business ownership interests and
other assets). Not all estates are liable for the federal estate tax. It is only levied on the part of an
estate's value that exceeds a certain exemption level, which for 2014 is $5.34 million per person
($10.68 million for a married couple). This exemption amount is indexed annually for inflation. In
addition to the federal tax, an estate may be liable for state estate or inheritance taxes.
Bottom line: You may hate certain taxes during your lifetime but if you're wealthy enough, you
will be paying the federal government even after you die.
Goodwill Amortization: A Taste of 'Little GAAP'
After years of listening to complaints from private firms and their auditors that certain
accounting rules were too costly and complex, the Financial Accounting Standards Board
(FASB) has finally taken action. On January 16, the FASB simplified one of the accounting rules
private firms most loved to hate: FASB Accounting Standards Codification Topic 350, Intangibles
-- Goodwill and Other.
Accounting for Swaps
Some private firms couldn't qualify for low-rate
fixed loans after the recession. Instead, they
turned to interest rate swaps to economically
convert variable rate loans into fixed rate
loans. But they discovered that accounting for
interest rate swaps -- considered derivatives
under GAAP -- was confusing and costly.
Old Rules: FASB Accounting Standards
Codification Topic 815, Derivatives and
Hedging, requires companies to recognize
interest rate swaps on the balance sheet as
either assets or liabilities and measure them at
fair value.
Although GAAP permits hedge accounting
under certain conditions, private firms often
lack the expertise to elect the simplified
method. This resulted in significant earnings
fluctuations -- and headaches -- for private
What Is Goodwill?
Goodwill shows up on a company's
balance sheet after a merger or an
acquisition. It's what is left over after the
company allocates the purchase price
to tangible and identifiable intangible
assets acquired and liabilities assumed.
Generally accepted accounting
principles (GAAP) requires goodwill to
be tested for impairment at least
annually, or more frequently if certain
conditions exist. If impairment occurs,
the company must reduce the carrying
value of goodwill on its balance sheet
and report an impairment loss on its
income statement.
The FASB's Change of Heart
When deciding whether to simplify the
rules for private firms that report
goodwill, the FASB solicited feedback
from business owners, auditors, lenders
and creditors. They discovered that
many financial statement end-users
disregard goodwill and impairment
losses in their evaluations of private
companies' financial condition and
operating performance.
firms.
Simpler Alternative: Now the FASB offers a
simplified hedge accounting approach for
private firms (except financial institutions) that
enter into qualifying interest rate swaps. Under
the amended standard, a private company
that uses a "plain-vanilla" interest rate swap
when borrowing money may qualify for hedge
accounting that treats the swap and loan as
separate financial instruments.
Essentially, interest expense under the
simplified hedge accounting approach is
similar to the amount that would result if the
entity had directly entered into a fixed-rate
loan. On the balance sheet, the company also
can measure the swap at settlement value, as
opposed to fair value, which is harder to
calculate.
This update reduces compliance costs and
income statement volatility. Private firms can
elect to apply the simplified hedge accounting
approach on a swap-by-swap basis to new or
existing swaps that qualify.
Like the goodwill standard, this change is
effective for most firms after December 15,
2014, but early adoption is allowed.
Because the existing rules provide only
limited value to private company stakeholders, the FASB decided to bend them prospectively for
any new and existing goodwill. Under the updated standard, private companies can elect to
amortize goodwill on a straight-line basis over 10 years (or less if the firm can demonstrate that
a shorter useful life is more appropriate). Amortization reduces the likelihood of impairment,
because it's already being written off the books over ten years (or fewer).
Triggering Events
Instead of testing for impairment every year, private companies only need to test when a
"triggering event" occurs. Examples include:
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A significant adverse change in legal factors or the business climate;
An adverse action or assessment by a regulator,
Unanticipated competition;
A loss of key personnel;
A more-likely-than-not expectation that the business (or a large segment) will be sold or
otherwise disposed;
Recoverability testing of a significant long-lived asset group; and
Recognition of a goodwill impairment loss for a subsidiary.
If a triggering event causes the fair value of the acquired business to fall below its carrying value,
the private company will incur an impairment loss. This represents a major simplification.
Private firms are no longer expected to reallocate fair value to all the acquired business's assets
and liabilities, a process that's similar to repeating the purchase price allocation the firm used
when the businesses originally combined.
The amended standard gives private companies the option to measure impairment at the entity
level. So, if an acquired division underperforms but the entity does well overall, the company
might not need to record goodwill impairment.
In light of the simplified standard for private firms, the FASB added the subsequent accounting
for goodwill for public companies and not-for-profit organizations to its agenda. So, broader
changes could be in the pipeline eventually.
How Soon Can You Apply the New Rule?
FASB Accounting Standard Update 2014-02 officially goes into effect for annual periods
beginning after December 15, 2014, and interim periods beginning after December 15, 2015. But
early adoption is permitted. So contact your accounting firm as soon as possible to take
advantage of the reduced compliance costs when reporting new and existing goodwill.
Consider Flexible Spending Accounts at Your Company
If your company doesn't provide health insurance -- or if you do provide coverage but your
employees are faced with increasing deductibles, co-pays or out-of-pocket expenses -- there's
no time like the present for taking a look at flexible spending accounts (FSAs).
A form of cafeteria plan under Section 125 of the Internal Revenue Code, a health care FSA
allows employees to set aside pre-tax dollars from their paychecks to pay medical and dental
expenses that are not reimbursed from an insurance plan. Eligible expenses are then
reimbursed from the employee's account. You can also offer flexible spending accounts for
dependent care expenses.
Flexible spending accounts offer several
advantages to your company and your
employees. However, there are also some
disadvantages to be aware of. One of the best
known is the "use it or lose it" feature. Any
amounts contributed to an account and not
spent by the end of the year are forfeited to
the employer. However, an IRS ruling issued a
few years ago softened this deadline
considerably. Employees can be given an
additional two-and-one-half months after the
end of the plan year to spend FSA funds, if the
employer amends its plan to allow for this
extension. (See the right-hand box for more on
this subject.)
Here are some more pros and cons of flexible
spending accounts for your company and its
employees:
From the Employer's Perspective
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Decreased taxable salary income for
employees, as a result of contributions
to reimbursement accounts, results in
decreased employer expenditures for
FICA tax, unemployment insurance,
workers' compensation and other
wage-based expenses.
Some or all of the cost for
administration is typically offset by the
FICA tax savings.
The primary area of concern for
employers is the "at risk" provision
associated with health care
reimbursement accounts. The "at risk"
provision requires that you reimburse
an employee for incurred eligible
expenses up to the full amount that he
or she has elected to set aside for the
entire plan year -- regardless of how
much he or she has actually
contributed up to that point.
How Much Can Employees
Contribute?
Before 2013, there was no statutory limit on
medical FSA contributions, although
employers often imposed restrictions.
However, the maximum annual contribution
to a health care FSA is capped at $2,500
beginning January 1, 2013 (indexed for
inflation after 2013).
There is a $5,000 annual limit on dependent
care FSA contributions.
Rules in Effect
In a welcome move for employees, the IRS
relaxed the rules involved in tax-saving
flexible spending accounts. Now, employees
may be able to get an extra 2 1/2 months
after year-end to spend the money set aside
in their accounts before they lose it. (IRS
Notice 2005-42)
In order to take advantage of the grace
period, however, employers must amend
FSA plans to permit the extra 2 1/2 months - through March 15 of the following year
(this assumes the FSA plan operates on a
calendar-year basis, which is almost always
the case). Employees can use any unspent
year-end balances to reimburse themselves
for qualified expenses incurred within the
grace period.
Essential to Understand
The use-it-or-lose-it rule still exists, but the
grace period greatly softens the blow by
allowing employees more time to use their
unspent FSA balances.
For example, let's say an employee has
elected to contribute $2,400 for the plan year and incurs $2,400 of eligible expenses at the end
of the second month. At this point, the employee has only contributed $400 to his account, yet
he is entitled to $2,400 in reimbursement. If the employee remains with your organization, he will
contribute the remaining $2,000 by year's end. However, he has no repayment obligation if he
leaves his job before the end of the year.
You can cap your company's liability by limiting the amount that employees set aside. Some
employers use a two-tiered capitation: Limiting first-year participants to $1,000, for example,
while they become accustomed to the program, and then capping future participation at a higher
amount, say $3,000.
There is also a flip side to this issue. An employee who leaves in the course of the year without
having expended any or all of what he has contributed to his account relinquishes the remaining
account balance to the employer, unless he continues participating through COBRA. Employees
also forfeit to their employers any unspent amounts left in their accounts at the end of the year
under the "use it or lose it" rule.
From the Employee's Perspective
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Reduced taxable salary income means employees reduce their federal income tax,
FICA tax and frequently, state income tax. Because an FSA reduces adjusted gross
income, it may make an employee eligible for other valuable tax benefits.
Employees can be reimbursed with pre-tax dollars for out-of-pocket deductibles, co-pays
and procedures that are not covered by their health care insurance (if they have
coverage).
For many employees, FSAs are the only way to get a tax break for medical expenses.
That's because medical expenses are generally only deductible to the extent they
exceed 10 percent of adjusted gross income in 2014 (unchanged from 2013).
Note: If you or your spouse is age 65 or older at year end, the new 10 percent-of-AGI
threshold will not take effect until 2017. You can still use 7.5 percent
Covering medical expenses with pre-tax dollars via FSAs provides employees with more
spendable income.
Employees are concerned about the "use or lose it" provision of health care accounts. If
an employee elects to contribute $2,400 for the plan year, but incurs only $2,000 of
eligible expenses, the remaining $400 reverts to the employer. However, planning and
past experience can result in accurate contribution-estimates. And the savings on taxes
may offset any loss.
While the "use it or lose it" provision can apply to dependent care accounts as well, there is
generally less risk. Employees find it easier to estimate what they will spend for dependent care
on an annual basis.
Also, be aware of several important changes for health care FSAs included in the Patient
Protection and Affordable Care Act. Under the health care legislation, over-the-counter drugs
and medicines are now excluded, unless prescribed by a health care professional. Also, the
maximum annual contribution to a health care FSA is now capped at $2,500.
If you are interested in learning more about FSA plans, talk with your tax adviser or benefits
consultant. Keep in mind that if you decide to implement an FSA plan, employee education is a
critical component for maximum participation.
Age Has its Privileges ... and Penalties
In an era filled with uncertainty, you can count on one thing: time marches on. Here are
some important age-related financial and tax milestones to keep in mind for you and your loved
ones:
Age 0 to 23. Under the Kiddie Tax rules, part of young person's investment income can be taxed
at the parent's federal rate (which can be as high as 39.6 percent for 2014 (unchanged from
2013) rather than at the young person's lower rate (usually only 10, or 15 percent depending on
the type of income).
The Kiddie Tax can bite until the year when the young
person turns 24. However, after the year the individual
turns 18, it can only bite if he or she is a student with
at least five months of full-time school attendance. For
2014, the Kiddie Tax can only hit investment income in
excess of the threshold amount of $2,000 (unchanged
from 2013). Investment income below the threshold is
taxed at the young person's lower rate.
Age 18 or 21. Did you set up a custodial account for
your minor child to help pay for college or save on
taxes? It will come under the child's control when he or
she reaches the local age of majority (generally, age
18 or 21 depending on your state of residence).
Age 30. If you set up a Coverdell Education Savings
Account (CESA) for a child or grandchild, it must be
liquidated within 30 days after he or she turns 30 years
old. Earnings included in a distribution that are not
used for qualified education expenses are subject to
federal income tax, plus a 10 percent penalty.
Alternatively, the Coverdell account balance can be
rolled over tax-free into another CESA set up for a younger family member.
Age 50. At this age, you can begin saving more for retirement on a tax-favored basis. If you're
age 50 or older as of the end of the year, you can make an additional catch-up contribution to
your 401(k) plan, 403(b) plan, Section 457 plan, or SIMPLE plan, assuming the plan permits
catch-up contributions. You can also make an additional catch-up contribution to a traditional or
Roth IRA.
Age 55. If you permanently leave your job for any reason, you can receive distributions from the
former employer's qualified retirement plans without being hit with the 10 percent premature
withdrawal penalty tax. This is an exception to the general rule that a 10 percent penalty is due
on distributions received before age 59 1/2.
Age 59 1/2. For any reason, you can receive distributions at age 59 1/2 from all types of taxfavored retirement plans and accounts without being hit with the 10 percent premature
withdrawal penalty tax. This includes IRAs, 401(k) plans, pensions and tax-deferred annuities.
Age 62. At this age, you can elect to start receiving Social Security benefits. However, your
benefits will be lower than if you wait until reaching full retirement age (see "Age 66" below).
When considering this election, look at your health and your family's history of longevity.
Also, if you continue working after starting to collect benefits but before reaching full retirement
age, your Social Security benefits will be further reduced if your income from working exceeds
$15,480 in 2014 (up from $15,120 for 2013).
Age 66. After years of paying into the system, you can start receiving full Social Security
benefits. However, the age to collect full benefits is creeping upward. For example, if you were
born between 1943 and 1954, it's 66. And if you were born in 1960 or later, you will have to wait
until age 67 to collect full benefits. If you reach age 66 in 2014, your benefits will be reduced if
you are still working and your earnings exceed $41,400 (up from $40, 080 in 2013).
Want to keep working? You won't lose any benefits if you work in years after the year you reach
full retirement age, regardless of how much money you make.
Age 70. You can choose to postpone receiving Social Security benefits until after you reach age
70. If you make this choice, your benefit payments will be more than if you had started receiving
them earlier. They will be increased by a certain percentage (depending on your date of birth).
Important: If you decide to delay retirement, be sure to sign up for Medicare at age 65. In some
cases, medical insurance costs more if you delay applying for it.
Age 70 1/2. You generally must begin taking annual minimum required distributions from taxfavored retirement accounts (including traditional IRAs, SEP accounts and 401(k) accounts), and
pay the resulting income taxes. However, you need not take any such mandatory distributions
from your Roth IRA.
The initial minimum required distribution is for the year you turn 70 1/2, but you can postpone
taking that payout until as late as April 1st of the following year. If you chose that option,
however, you must take two minimum required distributions in that following year. One must be
taken by April 1st, which is the one for the previous year, plus another by December 31st, which
is the one for the current year. For each subsequent year, you must take your minimum required
distribution by December 31st.
There's one exception: if you're still working after reaching age 70 1/2, and you don't own over 5
percent of the company, you can postpone taking any minimum required distributions from the
employer's plan(s) until after you've retired.