Planning for Taxes in an
Uncertain Environment
James F. Knight, CPA
• “This is a question too difficult for a
mathmatician. It should be asked of a
philosopher”.
– Albert Einstein, about filling out his tax form in
1944
What we’ll talk about
• Expiration of President Bush’s 2001 &
2003 tax cuts
• Immediate(1/1/13) impact of the Patient
Protection and Affordable Care Act
(PPACA) & Health Care and Education
Reconciliation Act of 2010 (HCERA)
• Long-term implementation of PPACA &
HCERA
Expiration of Bush tax cuts
• Originally extended in December of 2010
• Set to expire December 31, 2012
– Political uncertainty vs. conventional wisdom
Expiration of Bush tax cuts
• Some key notable changes include;
– Top rates increase from 33% to 36% and from
35% to 39.6%
– Top long-term capital gains tax rate will
increase from 15% to 20%
– Qualified dividends will no longer be subject
to preferred tax rate of 15%. They will be
subject to ordinary tax rates.
Expiration of Bush tax cuts
• Some key notable changes include;
– Itemized deductions will again be phased out
by the lesser of (a) 3% of the excess of
adjusted gross income over an applicable
amount or (b) 80% of the amount of the
itemized deductions otherwise allowable for
such taxable year.
Expiration of Bush tax cuts
• Some key notable changes include;
– Estate, gift and generation-skipping transfer
tax exemptions will be reduced from $5.12
million to $1million and maximum transfer
rates will increase from 35% to 55%
2013 Impact of PPACA
• Key Provision
– Addition of FICA Hospital Insurance Payroll
Tax
• High-income earners will be subject to an
additional payroll tax of 0.9% on wages received in
excess of the following threshold amounts;
– Married filing jointly - $250,000
– Married filing separately -$125,000
– Single or head-of-household - $200,000
2013 Impact of PPACA
– Addition of FICA Hospital Insurance Payroll
Tax
• FICA (Federal Insurance Contributions Act)
– Social Security portion (4.2% of wages up to $110,000)
– Medicare portion (1.45% on all wages)
» Employer “match” -6.2% SS, 1.45% Medicare
• New 0.9% added to Medicare tax on wages
earned in excess of the applicable threshold
amounts for a combined employee Medicare rate
of 2.35%
Addition of FICA Hospital
Insurance Payroll Tax
• The additional tax applies to wages and
self-employment income
• It will not be adjusted for inflation
• It will not qualify for the above-the-line
deduction for 50% of SE tax.
• Need to be considered for estimated tax
purposes.
Addition of the 3.8% Medicare
Contribution Tax
• Beginning in 2013, a new 3.8% Medicare
tax will be imposed on certain unearned
income of individual, trusts, and estates.
• This tax is in addition to any other income
taxes a taxpayer may owe.
Addition of the 3.8% Medicare
Contribution Tax
• For individuals, the tax is calculated by
multiplying the 3.8% rate by the LESSER
of;
– Net investment income for the year, or
– Modified adjusted gross income (MAGI)
exceed the threshold amount
Addition of the 3.8% Medicare
Contribution Tax
• Net investment income is unearned
income including;
– Interest, dividends, capital gains
– Annuities, rents and royalties
– Passive income from a business
– Net gain on the sale of a principal residence
in excess of the current exclusion amounts
– Gain on the disposition of passive activity
property
Addition of the 3.8% Medicare
Contribution Tax
• Net investment income does NOT include;
– Pension, IRA, Profit sharing plan distributions
– Tax-exempt income
– Income subject to self-employment tax
– Royalties from oil and gas production, with
exceptions
Addition of the 3.8% Medicare
Contribution Tax
• Lessor of Net investment income or MAGI
over the threshold amounts;
– Married filing jointly - $250,000
– Married filing separately - $125,000
– Single or head-of-household - $200,000
Addition of the 3.8% Medicare
Contribution Tax
• If a taxpayer has net investment income
but their MAGI is below the threshold
amounts, they will not be subject to the tax
• If a taxpayer has MAGI above the
threshold but has no net investment
income, they will not be subject to the tax.
Addition of the 3.8% Medicare
Contribution Tax
• Example
– Harry and Teri, a married couple filing a joint
return, have 2013 MAGI of $350,000 and
$60,000 of net investment income.
– They will owe 3.8% medicare contribution tax
on $60,000 or $2,280.
Addition of the 3.8% Medicare
Contribution Tax
• The MC tax also applies to estates and
trusts.
– 3.8% applies to the lesser of (a) the
undistributed net investment income or (b) the
AGI over the amount at which the highest
trust and estate tax bracket begins
• Over $11,650 for 2012
– Tax doesn’t apply to trusts that don’t have
undistributed income (simple trusts)
Combined effect on tax rates
Source of income
2012
2013
Maximum Maximum Total maxumum tax rate Total maximum tax rate if
Rates
Rates
If subject to additional subject to additional 0.9%
3.8% MC Tax
FICA-HI tax
Long-term capital gains
15%
20%
23.80%
N/A
Qualified dividends
15%
39.60%
43.40%
N/A
Ordinary income(excluding wages)
35%
39.60%
43.40%
N/A
Wages (includes wage earner's
36.45% 41.05%
N/A
41.95%
1.45% Medicare payroll tax)
Strategies in anticipation of higher
rates
• Accelerate income
– Bonuses, commissions
– Convert to a ROTH in 2012
• Not subj to minimum distribution requirements
– Consider exercising nonqualified stock
options
– Sell appreciated property prior to year end
• Stocks, principal residence, other real estate
Strategies in anticipation of higher
rates
• Reset low basis positions
– Wash sale rules don’t apply to gains
Strategies in anticipation of higher
rates
• Defer income
– Increase retirement contributions
• IRA contributions reduce MAGI and future
distributions are not considered net investment
income
• 401(k) contributions reduce MAGI and wages
subject to MC tax
• Consider tax-deferred annuities
• Life insurance-tax deferred growth free from
current income tax and MC tax.
Strategies in anticipation of higher
rates
• Reduce income
– Municipal bonds
– Growth investments
– Consider gifting assets that produce net
investment income
Estate planning strategies
• Take advantage of current $5.12 million
exclusion
– Important even if estate is not in $5 million
range
– Consider correcting gifting inequities
– Trusts help keep control if beneficiaries not
ready
Business planning
• Expiration of bonus depreciation
• Reduction of Sec. 179 limit
– Current $139,000 with $560,000 investment
ceiling
– Drops to $25,000 with a $200,000 investment
ceiling
• Entity selection to reduce SE tax.
Other effects of the legislation
• 2012 - Disclosure of health benefits on
employees W-2
» Supposed to be effective in 2011 but mandator in
2012
Other effects of the legislation
• 2013
– Medical expense threshold
» Under 65 –increases to 10% of AGI
» Over 65 -remains 7.5%
– Fee imposed on health plans
» $1 per covered person in 2013, $2 in 2014
– Maximum flexible spending provision for
medical expenses capped at $2,500
Other effects of the legislation
• 2014
– Premium assistance credit
• Refundable credit for individuals with HH income
between 100% and 400% of federal poverty level.
– Excise Tax on Uninsured
• New law requires citizens and legal residents to
maintain minimum health insurance coverage.
– Penalties will be greater of 2.5% of amount by which
household income exceeds amount requiring filing of
return or $695 per uninsured adult in household
Other effects of the legislation
• Excise Tax on Uninsured(cont’d)
– Individuals or employers will be offered a
variety of optional coverage packages with
different deductibles, copays, etc. but all
offerings will meet federally mandated
minimum coverage requirements.
– Federal government will subsidize cost for
those with relatively low income.
Other effects of the legislation
• 2014 (cont’d)
– Expanded employer/administrator reporting
– “Qualified benefit” through exchange
• Individual pays and claims credit or fed pays credit
directly to the exchange and individual pays the
difference.
– Employer penalty
• “applicable large employer” that fails to provide
affordable “minimum essential coverage”
Questions/Comments
• Thank you for being a valued friend of St.
Clair CPAs