Financial Planning Association of Ventura County Tax Update 2014 - - PDF document

Financial Planning Association

• f Ventura County

Tax Update 2014 New Tax Laws and Developments

January 17, 2014 By Boyd D. Hudson Attorney at Law and Charles G. Stanislawski, M.B.T., C.P.A.

Be sure and talk with your tax attorney, CPA or tax preparer. There is so much interplay between the numerous tax planning alternatives that it is critical that you discuss it with your tax professional. This is a very complicated area. This handout is provided for informational purposes only, and should not be conveyed as specific tax or legal advice on any subject matter. You should contact your attorney or C.P.A. to obtain advice with respect to any particular issue or problem. Use of this handout does not create an attorney-client relationship, nor will any information you submit to us via e-mail be considered an attorney-client communication or otherwise be treated as confidential or privileged in the absence of a pre-existing express agreement by us to the contrary. The content of this handout contains general information and may not reflect current tax or legal developments, verdicts or negotiated settlements. The content of this handout may be considered advertising for tax and legal services under the laws and rules of professional conduct in the jurisdiction in which we practice. Prior results do not guarantee a similar outcome. If you have questions regarding the above tax rules, regulations, recommendations and advice please contact us. Contact information is located on the last page of this handout.

TABLE OF CONTENTS

I. Highlights of 2013 and 2014 II. The American Tax Relief Act of 2012 III. Bonus Depreciation (Special Depreciation) and IRC §179 IV. IRA’s - Contributions to Charities and Roth Conversions V. Estate and Gift Tax Developments VI. Form 1099 – Miscellaneous Income Rules VII. Income Planning

• VIII. Adjustments to Income

IX. Investment Planning X. Wash Sales XI. Investment Interest & Expenses XII. Mutual Fund Investments

• XIII. Investment Income
• XIV. Planning for Itemized Deductions

XV. Family Strategies

• XVI. Retirement Strategies
• XVII. Year-End Planning for Business Owners
• XVIII. Estimated Tax Payments
• XIX. Other Tax Credits

XX. Other Items

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• I. Highlights for 2013 and 2014

Albert Einstein once said, “The hardest thing in the world to understand is the income tax” and how right he was as 2013 and 2014 are full of changes as usual with plenty of new provisions and expiring provisions alike. Below is a list of some of these changes with many being covered in more detail throughout the handout.

• 1. 2013 federal income tax rate brackets for individuals, estates and trusts were adjusted for

inflation; however, the top federal tax rate for 2013 increased from 35% to 39.6% for single filers with taxable incomes over $400,000, $425,000 for Head of Household, $450,000 for Married Filing Joint and Surviving Spouse, and $225,000 for Married filing Separate filers. The 2014 federal tax rates are expected to remain the same with the tax brackets being adjusted for

• inflation. Furthermore, due to California voter approval of Proposition 30, California personal

income tax rates for high income earners will be 10.3%, 11.3% and 12.3% effective for tax years 2012 through 2018. For California taxpayers with taxable income above $1 million, an additional 1% tax is assessed (referred to as the Mental Health Services Tax), making the top California tax rate 13.3%.

• 2. The AMT exemption patch was made permanent and is now annually adjusted for inflation

beginning in 2012; phase outs apply.

• 3. Beginning in 2013 and continuing through 2014, long term capital gains and qualified dividends

are taxed at a maximum tax rate of 20% for high income taxpayers (those subject to the 39.6% tax rate). In addition, the new 3.8% surtax on net investment income and gains will increase the maximum capital gains rate to 23.8% for higher–income taxpayers with modified adjusted gross income exceeding $200,000 for single filers, $250,000 for joint filers and $125,000 for married filing separately. For taxpayers in the 25% to 35% tax bracket the capital gains rate will be 15% and an additional 3.8% surtax, if applicable, brings the maximum rate to 18.8%. The 0% capital gains tax rate will continue for taxpayers in the 10% and 15% tax brackets.

• 4. Beginning in 2013 – 0.9% additional Medicare Tax on employee’s earned income meeting

income thresholds.

• 5. The 2013 standard mileage rate for business travel was 56.5¢ per mile. For 2014, the standard

mileage rate for business is 56¢ per mile. Charitable miles remains 14¢ per mile for 2013 & 2014 whereas the standard mileage rate for medical and moving mileage goes from 24¢ per mile in 2013 down to 23.5¢ per mile for 2014.

• 6. Beginning in 2013, personal exemptions can be phased out. The exemption amounts phase out

by 2% for each $2,500 (or fraction thereof) by which the taxpayer(s) AGI exceeds the threshold

• amount. The 2013 AGI threshold is $250,000 [$254,200 in 2014] for a single filer, $275,000

[$279,650 in 2014] for Head of Household, $300,000 [$305,050 in 2014] for married filing joint and surviving spouse, and $150,000 [$152,525 in 2014] for married filing separate filers. The threshold amounts are inflation adjusted annually.

• 7. The enhanced version of the student loan interest deduction has been made permanent. The 60-

month limitation has been eliminated and the maximum above the line deduction is $2,500 but, AGI limitations apply.

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• 8. Itemized deduction phase out returns in 2013. A taxpayer’s itemized deductions are reduced by

3% of the excess AGI over the threshold amount not to exceed 80% of the total itemized deductions (yes, itemized deductions can be reduced and limited to only 20% of the actual amount!). The 2013 AGI threshold is $250,000 [$254,200 in 2014] for a single filer, $275,000 [$279,650 in 2014] for Head of Household, $300,000 [$305,050 in 2014] for married filing joint and surviving spouse, and $150,000 [$152,525 in 2014] for married filing separate filers. The threshold amounts are inflation adjusted annually.

• 9. Beginning in 2013 – The threshold for deducting medical expenses as an itemized deduction will

increase from 7.5% to 10% of adjusted gross income. For tax years 2013 through 2016, the 7.5% floor continues to apply for individuals who reach age 65 before the close of the tax year. For California, the threshold will continue to be 7.5% of adjusted gross income.

• 10. Debt resolution fees may be allowed as an itemized deduction (subject to 2% floor).
• 11. $1,000 per-child tax credit has been extended permanently. Income phase out applies.
• 12. Dependent and child care credit is permanently extended. Income phase out applies.
• 13. American Opportunity Tax Credit (for education) is extended through 2017. Income phase out

applies.

• 14. The annual gift tax exclusion was increased to $14,000 for 2013 with the exclusion remaining

the same for 2014. Beginning 2013, the gift tax rate will be 40% and the gift tax exemption will be $5 million adjusted annually for inflation.

• 15. For decedents dying in 2013 the estate tax exclusion amount was $5,250,000 with a top estate tax

rate of 40%. The annual exclusion amount is adjusted annually for inflation. The exclusion amount for 2014 will be $5,340,000 and the estate tax rate will be 40% as this amount was made permanent by the American Taxpayer Relief Act of 2012. The surviving spouse may be able to use the “spousal portability” election; this election was made permanent after December 31, 2012.

• 16. The 30% residential energy efficient property credit (IRC25D) for installation of qualified solar,

geothermal and small wind energy property applies to property placed in service through December 31, 2016 and there are NO AGI limitations.

• 17. Beginning in 2014, the California Franchise Tax Board (FTB) will begin accepting e-filed Form

541, California Fiduciary Income Tax Return, for the 2013 tax year (not for any pre-2013 tax years).

• 18. There are items, that were extended through or set to expire at the end of 2013, that as of January

10, 2014 have not been extended. There is the possibility of these and other items being retroactively extended through and possibly beyond 2014….stay tuned! (a) The election to deduct state and local general sales and use taxes, instead of state and local taxes is set to expire at the end of 2013. (b) 50% first-year bonus depreciation for “original use qualified property” is set to expire at the end of 2013.

3 (c) Internal Revenue Code Section 179 expensing limit of $500,000 and phase out for assets purchased in excess of $2 million is set to expire at the end of 2013. (d) 15-year accelerated recovery period allowed for qualified leasehold improvements, qualified restaurant property, and qualified retail improvement property is set to expire at the end of 2013 and will revert back to the 39-year recovery period. (e) The $250 above the line deduction for educator expenses is set to expire at the end of 2013. (f) The above-the-line deduction for qualified tuition expense is set to expire at the end of 2013. (g) The deduction of mortgage insurance premiums (PMI) is set to expire at the end of 2013. (h) The non-business energy credits (IRC 25C) is set to expire at the end of 2013. (i) A charitable contribution from Individual Retirement Accounts is set to expire at the end of 2013. (j) The 100% exclusion on the sale of qualifying small business stock (QSBS) is set to expire at the end of 2013. For QSBS stock purchased in 2014, the exclusion amount reverts back to 50%. (k) The cancellation of debt (COD) exclusion for principal residence is set to expire at the end of 2013. (l) Enhanced amounts for certain qualified transportation benefits (vanpool and transit passes) that qualify to be excluded from wages are set to be reduced at the end of 2013 (enhanced amount of $245 monthly reduced down to $130 monthly). (m) The Health Coverage Tax Credit that provides a refundable credit of 72.5% of qualified health insurance for individuals that receive pension benefits from the Pension Benefit Guaranty Corp. or who are eligible to receive a trade adjustment allowance is set to expire at the end of 2013.

• II. The American Tax Relief Act of 2012

The following is a summary of the principal provisions of The American Tax Relief Act of 2012 (the “Act”), approved by Congress and signed by the President several days ago.

• 1. Individual Tax Provisions

(a) Extension of Tax Brackets- For years after 12/31/2012, the 10%, 15%, 25%, 28%, 33%, 35% rates on taxable income at or below $400,000 [$406,750 in 2014] for individual filers, $425,000 [$432,200 in 2014] for heads of households and $450,000 [$457,600 in 2014] for joint filers are extended. Income above these levels are taxed at 39.6%. All tax bracket ranges will be adjusted for inflation.

4 The rates are made “permanent”. However Congress in the future could agree to change them. (b) Capital Gains/Dividends. The Act increases the top rate for capital gains and qualified dividends to 20 percent (20%). The new top rate will apply to the extent that a taxpayer’s income exceeds the threshold for the new 39.6% rate; i.e. $400,000 for single filers, $425,000 for HOH and $450,000 for joint filers. The zero percent (0%) rate on dividends and capital gains will continue to apply for those in the 15% regular tax bracket [$72,500 for MFJ and $36,250 for single filers or lower]. Everyone in between gets the benefit of the 15% rate for capital gains and qualified dividends. The 28% rate for gains on sales of collectibles and the 25% rate on Section 1250 recapture are unchanged. Payments made in 2013 and later on installment sales occurring before 2013 could be subject to the new 20% rate. Starting in 2013, under the Affordable Care Act of 2010, higher income taxpayers are subject to the 3.8% tax on net investment income (NII) including capital gains and dividends to the extent taxpayers have modified adjusted gross income exceeding $200,000 for single filers, $250,000 for joint filers and $125,000 for married filing separately. These provisions are unchanged by the new 2012 Act. Thus the rate on capital gains and dividends for taxpayers in the highest tax brackets will be 23.8% [20% + 3.8%]. (c) Alternative Minimum Tax Provisions. The Act increases the AMT exemption for 2012 with the use of the so-called “patch”. For years after 2012 the exemption amount is indexed for

• inflation. The inflation adjustment is finally permanent. The Act also provides that all

nonrefundable personal credits are allowed to the full extent of a taxpayer’s regular and alternative minimum tax liability for years after 2011. (d) Limit on Itemized Deductions. The Act brings back the limitation on the use of itemized deductions, the so-called “Pease” limitation, starting in 2013. However, the income thresholds the limitation applies are higher than what they would be without the Act. For 2013, the income [adjusted gross income] thresholds are: $300,000 for married filing jointly; $275,000 for heads of households, $250,000 for single filers; and $150,000 for married filing

• separately. The limitation reduces the total amount of a taxpayer’s itemized deductions by

three percent (3%) of the amount by which the taxpayer’s AGI exceeds the threshold. The application of the limitation cannot reduce the otherwise deductible itemized deductions by more than 80%. Certain itemized deductions such as investment interest, medical expenses and casualty losses are not subject to the limitation. (e) Phase out of 2013 Personal Exemptions. The Act also brings back the rule which phases out a taxpayer’s personal exemptions for higher income taxpayers. The phase out applies at the same adjusted gross income thresholds as the limitation on itemized deductions. The total amount of personal exemption that may be claimed by a taxpayer is reduced by two percent (2%) for each $2,500 or portion thereof by which AGI exceeds the threshold amount.

• 2. Estate Tax Provisions. The maximum estate tax rate for decedents dying between January 1, 2011

and December 31, 2012 was 35% with a $5 million exclusion for 2011 and $5.12 million for

• 2012. Absent the Act, the exclusion would have reverted back to $1 million along with a

maximum rate of 55% for 2013. The Act permanently provides for a maximum forty percent

5 (40%) rate with an exclusion of $5 million. Because of inflation adjustments, the exclusion for 2013 will be approximately $5,250,000 [$5,340,000 in 2014]. For gift tax purposes, the Act provides for a 40% maximum gift tax rate and an exemption of $5 million, subject to inflation adjustments. The estate and gift tax systems are now permanently unified. The Act makes permanent the “portability” provisions that were effective for decedents dying between January 1, 2011 and December 31, 2012. Portability allows the unused exclusion amount of the first spouse to die to pass to the surviving spouse to use for transfers made by the surviving spouse during life or at death.

• III. Bonus Depreciation (Special Depreciation) and IRC §179
• 1. Special first year bonus depreciation allowance of 50% for qualified property is allowed for
• 2013. Currently, the tax law does not extend bonus depreciation past December 31, 2013.
• 2. To qualify for special depreciation, the asset must generally be new, rather than used. Taxpayers

can elect not to claim special depreciation for any class of property.

• 3. If the special depreciation allowance is taken, there are no Alternative Minimum Tax (A.M.T.)

adjustments for depreciation for that asset for the year placed in service or any later year. This can be extremely advantageous for taxpayer’s subject to A.M.T.

• 4. California does not have bonus depreciation.
• 5. Comparison of bonus depreciation and IRC §179 for the 2013 and 2014 tax years (unless

Congress acts to extend all or some of the previous limits). 2013 2014 California Bonus Depreciation Bonus 50% 0% N/A Qualified Real Property 15 Years 39 Years N/A IRC §179 Maximum $500,000 $25,000 $25,000 Phase-out Range $2Million - $2.5 Million $200-K - $250-K $200-K - $250-K Qualified Real Property $250-K $0 N/A Computer Software Yes No No

• IV. IRA’s - Contributions to Charities and Roth Conversions
• 1. IRA Contributions to Charities: This provision was extended through 2013, but is one that

expired December 31, 2013 unless Congress acts some time in 2014 to retroactively reinstate this

• provision. Taxpayers over age 70 ½ were allowed to make tax-free transfers from an IRA

directly to a charity up to $100,000.

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• 2. Roth Conversions: From 2010 and later, taxpayers can convert funds from traditional IRAs and

qualified plans to Roth IRAs regardless of their modified AGI or filing status.

• 3. Participants of 401(k), 403(b) and government 457(b) plans with in-plan Roth conversion

features can make transfers to a Roth account at any time.

• V. Estate and Gift Tax Developments
• 1. The estate tax was repealed for decedents dying in 2010 but reinstated for decedents dying after

2010.

• 2. Decedents dying in 2013 the estate tax exclusion amount was $5,250,000 (per person/decedent).

For 2011 and thereafter the amount is increased by any deceased spousal unused exclusion amount (the spousal portability election). For 2014 the estate tax exclusion will be $5,340,000. The maximum estate, gift and generation skipping tax rate for 2013 and 2014 is 40%.

• 3. The annual gift tax exclusion amount for 2013 and 2014 is $14,000.
• VI. Form 1099 - Miscellaneous Income Rules
• 1. Every person (and also all nonprofit organizations) who operates an activity for gain or profit

must file Form 1099-MISC, Miscellaneous Income, for each person or business entity to whom you have paid during the year , including but not limited to: − $10 or more in royalties; − $600 or more for services (including parts and materials), rent, other income payments; − Any fishing boat proceeds; and − Gross proceeds of $600 or more paid to an attorney. (a) Exceptions. Some payments do not have to be reported on Form 1099-MISC, even though they may be taxable to the recipient, and include such items as: − Generally payments to a corporation (fees paid to an attorney, law firm, or provider of legal services always receives a 1099-MISC with payments reported in box 7 or 14 depending on the nature of the payment); − Payments for merchandise, telegrams, telephone, freight, storage, and similar items; and − Payments of rent to real estate agents (the real estate agent would be responsible to provide the property owner with a 1099-MISC).

• 2. Penalties for failure to file complete and accurate information returns or for filing late with the

IRS are as follows: − Failures corrected within 30 days: $30 per 1099. Maximum penalty: $250,000 per year or $75,000 for a small business;

7 − Failures corrected by August 1st: $60 per 1099. Maximum penalty: $500,000 per year

• r $200,000 for a small business; and

− Failures corrected after August 1st or for failure to file a return: $100 per 1099. Maximum penalty: $1,500,000 per year or $500,000 for a small business. A small business is defined as one in which average gross receipts for the 3 most recent years do not exceed $5 million. There are some exceptions to the penalty.

• 3. Beginning in 2011, credit card payment processors are required to make an annual information

report to the merchant and the IRS stating the gross amount paid to the merchant during the year

• n Form 1099-K, Payment Card and Third Party Network Transactions.
• 4. Form 1099-B, Proceeds From Broker and Barter Exchange Transactions. Brokers must report

cost or other basis of securities when sold: (1) corporate stock acquired after 2010 and (2) mutual fund shares, dividend reinvestment plan stock and ETF shares acquired after 2011. The basis in shares sold but acquired before those dates are not required to be reported on Form 1099-B.

• 5. California generally follows federal rules for informational return reporting. Please note, if a

taxpayer is being audited by the Franchise Tax Board (FTB), the FTB can deny the deduction to a business for personal services paid if the necessary informational returns were not filed (W-2

• r 1099).
• VII. Income Planning
• 1. Wages and Salaries. Wages and salaries are generally included in income in the year the

services were performed.

• 2. Interest. An individual must include bond interest in the year of payment. U.S. Government
• bligation interest is taxable for Federal purposes, but not California purposes. California and

local bond interest is excludable for both Federal and California purposes. Non-California municipal bonds are excludable for Federal purposes, but taxable in California.

• 3. Dividends. Payments an individual receives for owning stock are called dividends. Corporate

distributions can also be nontaxable return of capital, which will reduce a shareholder’s tax basis in the stock. If the taxpayer reinvests dividends through a stock reimbursement plan, the taxpayer still pays tax in the year the dividend was paid. (a) For tax years beginning 2013, the top tax rate increased to 39.6% and applies to individuals with taxable income of more than $400,000, to Head of Household filers with taxable income greater than $425,000, Married Filing Joint with more than $450,000, and to Married Filing Separate filers with more than $225,000. The thresholds are adjusted for inflation annually. (b) For tax years 2013 and 2014, qualified dividend and long term capital gain income will be taxed at a maximum rate of 20% (only for the 39.6% tax bracket). For taxpayers in the 10% and 15% tax brackets the rate is 0% and in the 25% to 35% tax brackets, the tax rate on qualified dividend and long term capital gain income is 15%. (c) For tax years beginning 2013, the Health Care Act imposes an additional Net Investment Income Tax (NIIT) of 3.8% on the lesser of net investment income or the excess of modified

8 adjusted gross income above threshold amounts (which are the same thresholds as the Medicare Hospital Insurance tax and not currently scheduled to be adjusted for inflation) for individuals, estates, and trusts. (d) The NIIT will be calculated on the new Form 8960, Net Investment Income Tax-Individuals, Estates, and Trusts. (e) For tax years beginning 2013, the Health Care Act imposes an additional .9% Medicare Hospital Insurance (HI) tax on wages and self-employment income on amounts earned over threshold amounts. The HI tax will be reconciled on the new Form 8959, Additional Medicare Tax. (f) For tax years beginning 2013, employers must begin withholding the additional HI tax when wages subject to Medicare exceed $200,000. Employer’s rate of 1.45% does not change. (g) Remember that securities held in tax-deferred retirement accounts such as an IRA will not be affected by changes in the tax rates for qualified dividends and long-term capital gains as the distributions from such an account will be ordinary income when distributed. (h) Beginning January 1, 2014, taxpayers who complete a like-kind exchange of California property for property located out-of-state will be required to file an information return with the Franchise Tax Board in the year of the exchange and for each subsequent year that the gain or loss is deferred; regardless of the filing requirements of the seller/exchanger.

• 4. Self-Employment Income. Sole proprietorship and single member limited liability company (if

treated as a disregarded entity for tax purposes), income is reported on Schedule C of Form 1040. No separate return is required (if a CA Single Member LLC, a short form filing and payment is required for CA, not fed). The owner’s net income is fully subject to self-employment tax. If the owner actively participates, losses are fully deductible against the income. Net operating losses (NOL) may be carried back (generally carried back 2-years) and/or forward (generally the carry-forward period expires for unused NOL’s after 20-years). (a) California – All taxpayers may use NOL’s again starting in 2012 and carry forward unused

• amounts. NOL’s generated in the 2013 and 2014 tax years can be carried back 2-years in

limited percentages, 50% and 75% respectively, with any unused NOL carrying forward for 20-years. NOL’s incurred for and after the 2015 tax year, a 100% of the NOL can be carried back 2-years.

• 5. Partnerships, Limited Liability Companies (LLC) and S Corporations. A partner in a partnership,

a member of an LLC or a shareholder in an S corporation must report their distributable share of income on Schedule E page 2 of Form 1040, even if the income was not paid to the partner or shareholder in cash or property. The reportable amounts will be on a Schedule K-1. (a) Income and loss from a partnership can sometimes be considered a “passive” investment. If the taxpayer is a material participant in the activity, i.e. the taxpayer is involved on a regular, continuous and substantial basis, it is an “active” investment and can deduct their share of losses against other active income. e.g., wages or self-employment income. (b) However, if the involvement is passive, then any losses can only be offset against passive

• income. If the taxpayer only has passive losses, the losses are suspended, and can only be

9 used to offset passive income in a future year or against active income when the investment is sold. (c) California – A foreign (out-of-state) LLC must register if doing business in California. Doing business means “actively engaging in any transaction for the purpose of financial or pecuniary gain or profit.” (R&TC §§17941, 23101) In addition, a foreign LLC will be considered doing business in California if one or more managing members are California residents; even if the LLC has no California source income. The LLC must prove otherwise.

• If a California resident member (not a managing member) performs a “for profit”

transaction on behalf of the LLC in California, the LLC would be considered doing business in California.

• A California resident passive member, who does not act on behalf of the foreign LLC

will not cause the foreign LLC to be doing business in California.

• A foreign LLC that fails to register and file in California may encounter the following:
• Subject to a penalty of $2,000 per year for failing to file and register as a foreign

LLC.

• Annual assessment of the $800 annual tax.
• 25% penalty for failure to file a return, interest, and the possibility of other penalties

as well.

• Lack the ability to bring suit or enforce a contract in California.
• 6. Taxable Distributions from an IRA. Distributions from traditional Individual Retirement

Accounts (IRAs) are taxable as ordinary income. Distributions prior to age 59 and one-half (59 ½) may be subject to a 10% excise tax penalty in addition to the income tax.

• 7. Social Security Benefits. If a taxpayer has income over a “base amount” that is received in

addition to Social Security benefits, a portion of the taxpayer’s Social Security benefits may be

• taxable. If 2013 modified adjusted gross income exceeds $44,000 (for joint filers), $0 (for

married filling separately) or $34,000 (for single filers or head-of-household), up to 85% (the maximum percentage) of the benefits may be taxable. (a) Individuals age 66 and older can earn an unlimited amount without losing Social Security benefits. (b) Workers receiving Social Security retirement benefits before their full retirement age (FRA), age 62 to 66 can earn up to $15,120 (2013) before benefits are reduced. For 2013 the earnings will be up to $15,480.

• VIII. Adjustments to Income
• 1. In arriving at Adjusted Gross Income (AGI), certain items are deductible:

(a) Contributions to an IRA. Contributions to a traditional IRA are deductible up to $5,500 ($6,500 if age 50 and older) in 2013 and 2014. If a taxpayer or spouse is covered by an employer plan, the ability to deduct an IRA contribution may be limited.

10 (b) SEP, SIMPLE or Keogh Plan Contributions – Elective deferral limitations. (c) 401(k), 403(b), SARSEP 457 – For 2013, deductible up to $17,500 ($23,000 if age 50 and

• lder). For 2014, up to $17,500 ($23,000 if age 50 and older).

(d) SIMPLE (savings incentive match plans for employees) – For 2013, deductible up to $12,000 ($14,500 if age 50 and older). For 2014, up to $12,000 ($14,500 if age 50 and older). (e) SEP (simple employee pensions) – Self-employed, for 2013 up to 20% of net self- employment (SE) income after SE tax deduction up to a maximum contribution of $51,000. If contributions made to self-employed, they must be made to eligible employees (f) SEP – Eligible employee, for 2013, 25% of wages up to a maximum contribution of $51,000. (g) Alimony. Alimony payments are deducted by the payer and included in income by the recipient. (h) Self-Employment Tax. One-half of self-employment tax is deductible in determining AGI. (i) Penalty for the Early Withdrawal of Savings. (j) Student Loan Interest. For 2013 a taxpayer can deduct up to $2,500 of interest on student

• loans. The deduction is phased out as AGI increases.

(k) Tuition and fees deduction. Extended through 2013 and income phase out applies. This deduction expired on December 31, 2013 unless Congress retroactively reinstates for 2014. (l) Self-employed Health Insurance Costs. Self-employed taxpayers, greater than 2% S- corporation shareholders, partners and LLC members can deduct 100% of the amounts paid for health insurance for themselves, their spouse and dependents. For greater than 2% S- corporation shareholders, the premium must be reported as wages on their Form W-2. For partners and LLC members, the premium must be reported as guaranteed wages on their Schedule K-1. The premiums are not subject to Social Security and Medicare taxes. (m)

Educator Expenses. Extended through 2013, maximum deduction of $250. Deduction

allowed to primary and secondary teachers as well as other education professionals. This deduction expired on December 31, 2013 unless Congress retroactively reinstates for 2014. (n) Health Savings Accounts (HSA) Deduction. An HSA is a savings account set up exclusively for paying qualified medical expenses of the account beneficiary or the beneficiary’s spouse and dependents.

• To be eligible, an individual must be covered under a high deductible health plan

(HDHP) , not covered under any other non-HDHP, cannot be enrolled in Medicare, and cannot be claimed as a dependent on another person’s tax return. Contributions are limited based on under or over 55 years of age and a self-only or family plan.

• Contributions to an HSA are an adjustment to your income and reported similar to an

IRA contribution on your income tax return.

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• Withdrawals from an HSA are exempt from federal income tax if used for qualified

medical expenses. Health insurance premiums generally are not qualified expenses. There are exceptions.

• Withdrawals not used for qualified expenses are included in gross income and are subject

to a 20% penalty, except for disability, death or attaining age 65.

• California does not recognize HSAs.

− Contributions to an HSA are not tax-deductible − Earnings in the HSA are not tax-deferred. − Contributions and earnings create California basis in the HSA. − Distributions are not taxable. − Medical expenses paid with HSA proceeds are deductible on California return. (o) Certain Moving Expenses.

• Cost of moving household goods and personal effects, and
• Travel expenses (including lodging but not meals) for one trip by the taxpayer and each

member of the household. Household members do not have to travel together or at the same time. (p) Certain Business Expenses of Reservists, Performing Artists, and Fee-Basis Government Officials. (q) Domestic Production Activities Deduction.

• IX. Investment Planning
• 1. Capital Gains and Losses

(a) One of the most fertile areas for year-end tax planning involves the timely realization of capital gains and losses. Usually an investor has more control over the timing of these items. Therefore an understanding of the rules can result in savings. (b) Long-term capital gains were taxed at a maximum rate of 15% (0% if the taxpayer is in the 10% or 15% tax bracket) in 2012. For 2013 and thereafter, the maximum rate is 20% for higher income taxpayers. Since this rate is lower than the maximum rate on ordinary income, it makes sense to realize capital gains.

• Remember that long-term capital gains are those resulting from the sale of capital assets

held more than one-year. Taxpayers should start counting on the day following the day

• f acquisition. The same date of each following month is the beginning of the new
• month. The day the taxpayer sells the property is part of his holding period.
• The holding period for inherited property is automatically long-term.

12 (c) Capital Losses are deductible on a dollar-for-dollar basis against net capital gains. Excess capital losses are allowed to offset up to $3,000 of ordinary income. Unused losses can be carried forward indefinitely and expire upon death. (d) Planning Techniques for Capital Gains and Losses.

• If a taxpayer has a capital loss carryover or realized capital losses from 2013, he or she

should consider selling capital assets in 2014 that have unrealized capital gain.

• If the taxpayer already has realized capital gains, the taxpayer should consider selling

property with capital loss potential.

• If the taxpayer has sufficient deductions or losses from other activities (for example a

large business loss) to fully offset the capital gains, it may not be worthwhile to realize the capital losses as they may provide no current tax benefit.

• Short-term capital losses are first applied against short-term capital gains. Any excess

short-term capital loss will be applied against net long-term capital gain. If the taxpayer has a short-term gain after applying long-term capital losses, the gain will be taxed at

• rdinary income rates up to 39.6% for higher income taxes.
• Gains from collectibles held for more than twelve (12) months are taxed at a maximum

rate of 28%. Collectibles are items such as works of art, gems, stamps or antiques.

• Taxpayers should consider making a gift of appreciated property to a child who is in a

lower tax bracket. For example, a taxpayer in the 25% bracket who sells appreciated stock (with a basis of $2,000) for $8,000 has a capital gain of $6,000 on which he will pay $900 (15% of $6,000) of tax. If the taxpayer was planning to give the proceeds to his child, who presumably is in a lower tax bracket, he could do better by gifting the stock directly to the child. The child would take the same basis as the taxpayer, i.e. $2,000. The $6,000 realized gain would be taxed at the child’s rate of 0%, for a tax of $0. (e) It is important that in searching for capital gain opportunities that investors be aware of the "anti-conversion" rules that were enacted as part of the tax legislation of 1993. These rules were enacted to prevent taxpayers from reporting income at capital gains rates that should be reported as ordinary income where the investor is actually acting as a lender rather than an investor.

• The anti-conversion rules are directed toward transactions where all of the return is

attributable to the time value of money rather than the risk of gain or loss on the property. The Code provides that certain type of arrangements is subject to the anti-conversion rules.

• Example: Sam buys 1,000 shares of Marvel, Inc. for $2,000 on December 1, 2013. At the

same time, Sam agrees to sell the 1,000 shares to Jim on December 2, 2013 for $2,200. The anti-conversion rules apply. Sam entered into a contemporaneous agreement to sell the property when he bought it. Assuming the applicable federal rate is 6%, approximately $120 of Sam's gains will be taxable as ordinary income with approximately $80 taxable as capital gains. If Sam had no arrangement to sell the property to Jim under the same facts, the entire $200 of gain would be capital gains.

13 (f) The anti-conversion rules should not applicable to investors who make legitimate investments and who are willing to assume the risks that are inherently associated with the placement of investment capital. (g) Generally, securities acquired after 2010, brokers will be required to report not only the gross sales proceeds on the Form 1099-B, also the customer’s adjusted basis in the security and whether any gain or loss with respect to the security is long-term or short-term.

• X. Wash Sales
• 1. Wash Sales. A wash sale allows an investor to recognize a loss on the sale of a security without

giving up the security. However, in order to successfully use this technique, there are several timing rules that must be observed. (a) No deduction is allowed for a loss on the sale of a security if the taxpayer acquires substantially identical securities within a 61-day period beginning thirty (30) days before the sale and ending 30 days after the sale. (b) The obvious answer is to wait at least 31 days before repurchasing the stock. The problem with this approach is that any appreciation that occurs in the stock during the waiting period will be lost. (c) A second technique to purchase a second lot of the stock equal to the original holding, wait the requisite 31 days, and then sell the original lot at a loss. This allows for a continuing interest in the stock, but requires the taxpayer to have additional funds tied up for at least 31 days. (d) Another alternative is to sell the loss stock and buy stock of another company in the same industry that has performed the same way as the loss stock.

• XI. Investment Interest & Expenses
• 1. Investment Interest - General Rule. As a general rule investment interest expense can only be

deducted against net investment income. Any excess investment interest must be carried over.

• 2. Net Investment Income. In the past, investors were able to utilize capital gains against

investment interest expense. However, for years beginning after December 31, 1992, taxpayers can not classify their capital gains as investment income. Taxpayers can make an election to classify all or a part of their capital gains that are subject to the maximum rate of 39.6% as investment income. However, by making such an election, the amount of capital gains that are reclassified as investment income will be subject to ordinary income rates. (a) EXAMPLE. T has a net capital gain of $30,000 and investment interest expense of $12,000. T has no other investment income. T's taxable income subject to ordinary income rates is $500,000 with a maximum rate of 39.6%. If T makes the election to subject $12,000 of his capital gains to the higher 39.6% rate, he can utilize the $12,000 of investment interest

• expense. Thus, for an additional tax cost of $2,352 (19.6% of $12,000), T can save $4,752

(39.6% of $12,000). However, if T knew he would have at least $12,000 of regular

14 investment income, such as interest in 2013, and that his tax rate would be over 20%, it would be better to not make the election.

• 3. Whether or not to make the election requires a taxpayer to do some analysis of his or her actual

tax situation. The 20% rate on capital gains should not be sacrificed without careful consideration of the total picture.

• 4. Investment Expenses. Investment expenses such as office rent, investment counsel fees, legal

fees, safe deposit rental, subscriptions, and travel expenses offset investment income. These expenses must be related to the maintenance of investments. These investment expenses are treated as miscellaneous itemized deductions and are deductible only to the extent they exceed two percent (2%) of AGI. To receive the maximum benefits from these items, you should attempt to bunch these expenses in alternate years if possible.

• XII. Mutual Fund Investments
• 1. A mutual fund generally distributes most of its investment income to its shareholders. These

distributions may be taxable to the shareholders as ordinary income, capital gains, or may be tax- exempt income.

• 2. If the shareholder re-invests the distribution in mutual fund shares, the distribution is still
• taxable. The amount of the distribution does increase the taxpayer's tax basis in the investment.

(a) A shareholder may want to wait to buy mutual fund shares until after the fund makes a

• distribution. If you buy just before a distribution, part of your investment will be returned to

you as taxable income. (b) EXAMPLE. Bill purchases 400 shares of a mutual fund on February 1, 2013 for $4,000 and chooses to have all dividends re-invested in the fund. On June 1, 2013, Bill re-invests the $340 dividend from the fund to purchase 30 additional shares through the re-investment

• program. Bill must include the $340 as dividend income in 2013. Bill’s tax basis is

increased to $4,340 ($4,000 + $340). In July 2014, Bill sells all 430 shares for $5,640. In 2013, Bill must recognize long-term capital gain of $1,300. ($5,640 less $4,340).

• 3. Shareholders need to be careful when selling some of the mutual fund shares that they have

purchased at different times. It is crucial that the shareholders keep track of their basis. Different methods are available to mutual fund shareholders to determine their basis.

• 4. Taxpayers should consider the turnover rate of their mutual fund investments. Mutual funds

with a high turnover rate create capital gains, probably short-term capital gains.

• XIII. Investment Income
• 1. Interest Income. A Taxpayer can defer interest income into 2015 by purchasing U. S. Treasury

Bills now that mature in 2015. Interest on Treasury Bills and Bank CDs having a term of one- year or less is not includible in income until maturity.

• 2. Annuities. Taxpayers should consider purchasing annuities as a way to defer investment income.

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• 3. Municipal Bond Income. Taxpayers should be aware of what they would have to earn on a

taxable investment to match the yield on tax-exempt investments. This can be done be subtracting the marginal tax rate from one and dividing the result into the tax-exempt yield. Thus, if a taxpayer is in the 33% bracket, subtract .33 from one (1.0) to get .67. If the tax- exempt yield is 5%, the taxpayer would need a 7.5% return on a taxable investment to get the equivalent tax-exempt yield. Taxpayers should be careful to avoid private activity bonds since interest on these bonds are subject to the AMT.

• 4. Other.

(a) Like-Kind Exchanges. It may be possible to avoid a large gain by making a like-kind exchange of the asset. Like-kind exchanges are available for only certain types of business and investment assets. An exchange can postpone gain recognition until the exchanged asset is sold. A three-corner exchange may also be a viable alternative. (b) Installment Sales. By selling property using the installment method a taxpayer can defer the recognition of gain until the payments are received. A taxpayer can elect out of the installment method in order to accelerate the use of a capital loss from another sale.

• XIV. Planning for Itemized Deductions

Itemized Deductions can be used to reduce taxable income. However, it is important to recognize there are limitations on the availability of certain itemized deductions. Also one must keep in mind that overall itemized deductions can be limited if the taxpayer's adjusted gross income exceeds certain amounts.

• 1. Deductions - General - Unless the taxpayer is an accrual basis taxpayer, the deduction is

available in the year it is paid. If a taxpayer pays by check, the check should be dated on or before December 31 and be mailed by that date. The fact that the check is not cashed until after December 31 will not void the current deduction, if there is not a long delay from the date on the check and the date cashed. Payments for eligible deductions are qualified even if the money is

• borrowed. Taxpayers should consider a bank loan as a method of paying for eligible deductions.

Taxpayers should also consider using a credit card to pay for a deduction.

• 2. Medical Expenses. Medical expenses are deductible only to the extent they exceed 10.0% of

adjusted gross income. Medical expenses include prescription drugs, dental and insurance costs (including Part B Medicare premiums paid from Social Security benefits for taxpayers, spouses and dependents) and transportation costs for medical care. Because of this high threshold, many taxpayers who incur significant amounts of medical expenditures still do not qualify for a

• deduction. Planning should be to whenever possible to bunch medical expenses into one year.

For example, if the taxpayer has elective surgery, he should try to bunch all treatment and surgical expenses into one year in order to get over the 10.0% of AGI limitation. Note that the 10% penalty on early distributions from an IRA plans does not apply if the distribution is used to pay medical expenses. In addition, it may be possible to avoid the 10% penalty in IRA distributions that are used to pay health insurance premiums for unemployed individuals.

• 3. Tax Expenses. State and local income taxes are deductible in the year paid. Real estate taxes are

also deductible in the year paid. Note that if the taxpayer is in the Alternative Minimum Tax

16 (AMT) situation, such taxes are not deductible. With respect to income taxes, it is sometimes better to incur an Underpayment of Estimated Tax penalty for California purposes rather than pay a timely state estimated tax payment but lose the itemized deduction for taxes due to AMT

• liability. If AMT is not a problem, taxpayers should consider accelerating their 4th quarter 2014

California estimated tax payment (normally due January 15, 2015) and the second half of their 2014-2015 real property tax by paying them before December 31, 2013. On the other hand, if AMT is a problem, consider postponing the second installment of the property tax payment until the usual due date (April 10, 2015). (a) State and local general sales tax deductions have been extended through 2013 if using itemized deductions and sales tax is greater than income tax paid.

• Based on actual sales taxes paid if receipts are maintained;
• Estimated sales taxes paid per IRS sales tax table.
• 4. Charitable Deductions. Deductions to a qualified charity are deductible to the extent of 50% of

adjusted gross income. Be sure to ascertain that the charity is a qualified charity recognized by the Internal Revenue Service as a qualified Section 501(c)(3) organization. Note that pledges are not deductible. The pledge must be paid in order to qualify for a deduction. (a) Substantiation. Remember that charitable contributions of $250 or more must be substantiated by a contemporaneous written acknowledgment from the charity. A canceled check is no longer sufficient evidence of the deduction for a contribution of $250 or more. Even if contribution is less than $250.00, still necessary for taxpayer to retain such evidence as cancelled check or receipt to substantiate the deduction. (b) Gifts of Appreciated Property -- Taxpayers should consider gifts of appreciated property that they have held for more than one year. They should avoid the capital gains tax they would have to pay if they had sold the property, and they should be able to deduct the full fair market value of the property. Deductions for gifts of appreciated property are deductible to the extent of 30% of adjusted gross income.

• EXAMPLE. Bob and Sally donate marketable securities to the United Way worth

$30,000. They purchased the securities several years ago for $10,000. Their AGI for 2012 is $110,000. They may claim a charitable deduction for the full $30,000 since that is less than 30% of their AGI of $110,000. This deduction generates a tax savings of $7,500 (25% of $30,000). They also avoid paying tax on the $20,000 gain ($30,000 less $10,000) which at a 15% capital gain rate would be $3,000. (c) "In Kind" Contributions. If the taxpayer receives something in return for his contribution, he can only deduct the portion of the payment in excess of the value of what he received from the charity. (d) Appraisal. If the taxpayer makes gifts of property other than cash to the charity, he may have to obtain a contemporaneous appraisal if the claimed deduction is more than $5,000. The appraisal should be attached to the return. (e) Charitable Remainder Trust. A Charitable Remainder Trust (CRT) can give significant tax benefits while helping a charity. A taxpayer transfers highly appreciated assets to the trust

17 and receives an income either for life or a term of years. At the end of the taxpayer’s life or the term, the assets go to charity. The taxpayer gets a deduction for the remainder interest in the future value of the property. The trust will not pay any capital gains tax on the sale of the property. (f) Loss Property. If property has declined in value since it was acquired, taxpayers should consider selling the property first, recognizing a capital loss and then donate the cash to charity.

• 5. Mortgage Interest Expense. Generally, interest expense is deductible as it accrues and is paid.

Therefore, absent paying the January mortgage payment before year-end, it is difficult to accelerate interest expense. Deductibility depends upon the category in which the interest paid falls: business, passive activity, investment, personal, qualified residence or home equity

• indebtedness. One can generally deduct mortgage interest on the first $1 million of debt incurred

to acquire, construct or substantially improve a qualified residence. Interest on $100,000 of home equity debt is also deductible, regardless of how the funds are used. Generally, taxpayers cannot deduct personal interest, such as credit card or auto loans, and other interest may be limited.

• 6. Miscellaneous Expenses. These expenses include expenses to produce or collect investment
• income. Also included are expenses incurred to determine, contest or pay income tax, or to

make a claim for a refund of income tax. Also included are employee business expenses, such as travel, meals, lodging, education, equipment, special clothing, or professional dues if they are not reimbursed by the employer. In order to be deductible these expenses must exceed 2% of AGI. (a) Expenses of a Statutory Employee- Statutory employees include full-time life insurance salespersons, certain agents or commission drivers, certain traveling salespersons, and certain home workers. These taxpayers can deduct their unreimbursed business expenses as a direct deduction from gross income and thus avoid the restrictions placed on miscellaneous itemized deductions. Statutory employee expenses are deducted on Schedule C.

• 7. Casualty Losses.

(a) Given the severity of the natural disasters that occurred in California in recent years, it is important to keep in mind the rules regarding casualty losses. The following applies to personal-use property (for example your home). (b) The amount of the loss is the lesser of (1) the decrease in the fair market value of the property resulting from the casualty, or (2) the adjusted basis of the property. A taxpayer who suffers a loss must file a claim, if available, and insurance or condemnation proceeds must be deducted from the amount of the loss. (c) The deduction is further limited to that amount by which the loss (after any reimbursement) exceeds both $100 (for 2014) and 10 percent of the adjusted gross income. (d) A taxpayer who suffers a casualty loss which occurs in a federal disaster area may elect to deduct the losses if it occurred in the year immediately before the tax year of the disaster.

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• This election must be made on or before the later of: (1) the due date for filing the income

tax return (excluding extensions) for the tax year in which the disaster occurred, or (2) the due date (including extensions) of the tax return for the preceding tax year.

• XV. Family Strategies
• 1. Shifting Income to Your Children

In spite of the so-called Kiddie Tax, it may be possible to shift income to a taxpayer's children by putting property in their name and taking advantage of lower tax rates. (a) Under the Kiddie Tax the unearned income of a child age 18 and younger (as well as full- time students between the ages of 19 - 23) is taxed in the following ways:

• The first $1,000 in 2013 of unearned income is not taxed;
• Unearned income from $1,000 to $2,000 is taxed at the child’s tax rate; and
• Unearned income in excess of $2,000 for 2013 is taxed at the parents' marginal rate.

(b) Shifting property to kids that generates $2,000 of unearned income can save a family in the 35% bracket $700 in Federal tax. If the kid is 18 or older, the 15% rate applies to the first $36,250 of a single person's income (earned and unearned). (c) If a child is close to college age, instead of selling assets and recognizing gain at parents' tax rate consider giving the assets to the kids and having the kids sell the assets. (d) Owners of unincorporated businesses can hire their children. In 2013, a dependent child of any age can earn up to $6,100 [$6,200 in 2014] (amount of standard deduction) of wages tax-

• free. The parent can claim the expense as a business expense. Moreover, no Social Security
• r Medicare taxes apply to under-age-18 child's wages paid by an unincorporated business.
• 2. Dependency Exemptions

(a) For 2013 a taxpayer is allowed a $3,900 exemption for himself or herself and for each

• dependent. There is no phase out through 2012. Exemption phase out will apply in 2013 and

thereafter.

• 3. Gift Tax Annual Exclusion

(a) If the taxpayer has substantial assets, he can reduce his estate that will be subject to estate taxation by making gifts and taking advantage of the gift tax annual exclusion. (b) For 2012 taxpayers could make gifts of up to $13,000 per year of present interest per donee without affecting their lifetime unified credit. The exclusion cannot be carried over to future

• years. For 2013 and 2014 the annual exclusion amount increases to $14,000.

(c) Married couples can elect to split their gifts so that they are eligible to make gifts of $28,000 per donee, even if one spouse provides the assets to make the gift.

19 (d) Gifts used for tuition or medical expenses are not subject to the $14,000 annual exclusion. Donors can make their checks payable directly to the educational institution for tuition. Amounts paid for books, room and board do not qualify. (e) Amounts paid directly to health care providers for medical services on behalf of a donee are eligible for the unlimited gift tax exclusion.

• 4. Child Tax Credit.

Taxpayers may claim a nonrefundable credit of $1,000 for each child under the age of 17 at the end of the year. For taxpayers with incomes above $75,000 ($110,000 for married taxpayers filing jointly), the credit is phased out. The credit is reduced by $50 for each $1,000 or fraction thereof of modified AGI over the threshold.

• 5. Child and Dependent Care Credit – permanently extended.

(a) A credit is available to offset child care expenses to allow parents to work. The maximum qualifying expenses for the child and dependent care credit is $3,000 for one child and $6,000 for two or more qualifying children. The credit is available only if the taxpayer had earned income. The credit amount is based on AGI, and the qualifying child is under age 13. (b) Your employer may have a pre-tax dependent care benefit (DCB) plan. Employees may elect to have up to $5,000 MFJ ($2,500 MFS) excluded from gross income under an employer dependent-care assistance plan. On your Form W-2, these expenses are reported

• n box 10 as dependent care benefits and are not included as wages in box 1 and are exempt

from the Social Security and Medicare taxes. How does this work?

• For example, if you have two children and incurred dependent care expenses of $5,000

and you have $5,000 of DCB taken out of your wages to pay the dependent care expenses, the DCB amount is pre-tax dollars so you save Social Security (4.2% in 2012, 6.2% in 2013) and Medicare (1.45%) tax plus you avoided paying income tax on the $5,000 of compensation!

• Same example as above, except you incurred $6,000 in dependent care expenses. You

will be entitled to claim an additional $1,000 of child care expenses ($6,000 maximum expenses allowed to be claimed less $5,000 in DCB) on your tax return.

• Same example as above, except you incurred $4,500 in dependent care expenses. You are

required to report $500 of income on your tax return as DCB wages.

• Your employer’s DCB plan may provide for a grace period up to 2 ½ months after the

end of the plan year to incur dependent care expenses. For a calendar plan year (December 31, 2012) you can report dependent care expenses incurred until March 15, 2013 and report those amounts for 2012 DCB expenses. If your employer plan does not include this provision we recommend that they add it.

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• XVI. Retirement Strategies
• 1. Individual Retirement Accounts (IRAs) -

(a) The sooner a taxpayer makes the contribution, the more investment earnings can be accumulated before retirement. An individual who is under age 70 and one-half (70 ½) can deduct annual IRA contributions up to the lesser of $5,500 or 100 percent of compensation. Taxpayers, 50 years and older can deduct $6,500 per year. (b) If an individual is an active participant in a retirement plan for any part of the year, the deduction may be phased out depending on their modified AGI.

• Single or HOH - For 2013 the deduction phase out begins at modified AGI of $59,000

and is fully phased out at $69,000. ($60,000 to $70,000 for 2014).

• MFJ or QW – For 2013 the deduction phase out begins at modified AGI of $95,000 and

is fully phased out at $115,000 ($96,000 to $116,000 for 2014). If an individual is not covered, but the spouse is covered, the deduction for the individual’s contribution is subject to the deduction phase out if modified AGI for 2013 is from $178,000 to $188,000 (MFJ, QW); for 2014 the phase out is from $181,000 to $191,000. (c) Roth IRA. Through 2013, taxpayers can make nondeductible annual contribution of the lesser of $5,500 or your compensation (reduced by any contribution to other IRAs) to a Roth

• IRA. If age 50 or older, you can contribute an additional $1,000. Earnings in the Roth IRA

are not subject to tax while in the Roth IRA. The principal benefit is that distributions are not includible in income or subject to the 10% early withdrawal penalty if made more than five (5) years after the first contribution and distributed:

• On or after age 59 and one-half (59 ½);
• due to death;
• due to disability; or
• for first-time home buyers up to $10,000.

(d) Traditional IRAs can be converted to Roth IRAs. The income limit for conversions has been permanently removed, which means that all taxpayers can convert ordinary IRAs into Roth

• IRAs. You can take distributions up to the amount of contributions anytime tax free. You

can continue to make contributions to a Roth IRA even after 70 ½ which can’t be done with a traditional IRA. (e) Expansion of In-plan Roth conversion. Effective for transfers beginning 2013, a 401(k), 403(b) or 457(b) plan which permits Roth elective contributions can allow any amount in a non-Roth account to be converted to a Roth account. There are some differences between a qualified plan Roth program and Roth IRA’s:

• Recharacterization: There are no recharacterization provisions for a rollover into a

company Roth as there is with a Roth IRA.

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• RMD rules: Roth IRA’s are not subject to required minimum distribution (RMD) rules

whereas company Roth programs are subject to RMD.

• Basis ordering rules: Nonqualified distributions from a Roth IRA are considered to come

first from contributions and then from earnings and as such, are nontaxable and penalty free (as long as 5-year holding period has been met) until all basis has been recovered. For a company Roth the basis first recovery rule does not apply and basis is recovered ratably.

• Exceptions to 10% penalty: Certain distributions from a Roth IRA can be treated as a

qualified distribution not being subject to the 10% penalty; even though a qualifying event has not taken place:

• “First-time home purchases” [IRC §72(t)(2)(F)];
• Higher education expenses [IRC §72(t)(2)(E)]; and
• Health insurance premiums. [IRC §72(t)(2)(D)]

These events are NOT treated as qualifying events for a company Roth.

• Plan Loans: Company plans may include loan provisions to participants whereas loans

from an IRA (including Roth) are prohibited.

• 2. Self-Employed Plans

(a) These plans can be either defined contribution plans or defined benefit plans. Defined contribution plans provide for employer contributions to individual plan accounts for employees and the self-employed owner. There are no individual accounts in a defined benefit plan.

• For 2013 contributions to a defined contribution plan cannot exceed the smaller of

$51,000 ($52,000 for 2014) or 100% of the participant's compensation, not exceeding $255,000 ($260,000 for 2014).

• A type of defined compensation plan is a profit-sharing plan which does not require a

contribution every year unless the taxpayer wants to. (b) Because a defined benefit plan promises a certain benefit at retirement, the closer a taxpayer is to retirement the more that can be contributed to a defined benefit plan. (c) The plans must be established by December 31 to receive tax-deductible contributions for that year. The contributions must be made by the due date (including extensions) of the employer.

• 3. Simplified Employee Pension (SEP).

SEP-IRAs are available to self-employed (SE) individuals and their employees. Like Keogh plans, they provide for tax deferral on contributions and on investment earnings in the plan

• account. For the SE, the maximum of 20% of net self-employment income after SE tax

deduction up to a maximum contribution for 2012 of $51,000 ($52,000 for 2014). The maximum contribution allowed for the employee is 25% of their wages up to $51,000 for 2013 ($52,000 for 2014).

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• 4. Retirement Distributions

(a) Qualified Plan Rollovers - a taxpayer can postpone paying tax on a distribution from a qualified plan by rolling over the distribution into an IRA. The rollover must be done within 60 days.

• Taxpayers who plan on receiving a rollover should notify the administrator in advance.

The law requires plans to withhold twenty percent (20%) of all eligible rollover payouts for federal income taxes unless the plan transfers the funds directly to an IRA or another qualified plan.

• If the rollover is received directly by the employee, he will only receive 80% of the

amount; the other 20% will be applied to federal taxes withheld. The problem is that the employee will not have the full 100% to rollover into a new plan. (b) IRA Distributions -- Minimum distributions must begin by April 1st of the year following the year the taxpayer turns 70 and one-half (70 ½). (for a Roth IRA, minimum distributions are

• nly required after the death of the Roth IRA owner.)

(c) Premature Distributions -- There is a ten percent (10%) penalty on withdrawals made before a taxpayer turns fifty-nine and one-half (59½). However, if the taxpayer is in a low tax bracket (e.g. 15%) the taxpayer may consider taking a distribution and paying the penalty. This might be better than waiting when the tax-bracket could be higher. It also may be good planning if the taxpayer's deductions exceed his income for the year, which means only a 10% tax on withdrawal. The 10% penalty does not apply to distributions (1) due to death or disability; (2) used to pay medical expenses in excess of 7.5% of AGI; (3) used to purchase health insurance of an unemployed individual; or (4) made in a series of certain periodic payments for the life or life expectancy of the individual.

• 5. 401(K) Plans

(a) If a taxpayer's employer offers a 401(K) salary deferral plan, the taxpayer can contribute part

• f their compensation on pre-tax basis. In addition, investment earnings on the assets in the

plan are tax-deferred.

• In 2013, the amount of income that can be deferred is $17,500 ($17,500 for 2014). For

taxpayers over 50 years of age, the limit is $23,000 ($23,000 for 2014).

• Distributions from 401(K) Plans are taxed at the highest ordinary rate. Taxpayers may

want to consider allocating to the Plan assets that generate interest and dividend income, while allocating outside the Plan, assets that give rise to capital gains and losses. Taxpayers should look at their long-term investment goals. (b) Most 401(K) Plans allow participants to withdraw a portion of their account as loans. These loans must be repaid prior to distribution to the participant; otherwise the amount of the loan is considered a distribution in the year of termination.

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• 6. Pension – IRA – Roth Planning

(a) IRA Distributions to a charity. For 2013, withdrawals of up to $100,000 can be directly transferred to a charity and the withdrawal will not be added as taxable income to your individual income tax return. (b) Roth Conversions before age 59 and one-half (59½). In tax years that you have an extremely low or negative taxable income, it may be advantageous to convert part or all of your IRA into a Roth IRA. This conversion will be taxed at a very low rate or at no tax at all (if negative taxable income). Also in years where the balance of the IRA is low, you can actually convert more stock shares to a Roth because of the lower value of the IRA. (c) Roth Conversions Limitations disappear in 2010. Roth conversions were subject to income limitations; however, those income limitations expired in 2009. Therefore, even high income taxpayers will be able to roll over (convert) their IRA’s to a Roth starting in 2010.

• XVII. Year-End Planning for Business Owners
• 1. Equipment Write Off - Planning

(a) First Year Property Expense. For 2013, taxpayers can expense two different levels of depreciation for their business equipment or other tangible property used in a trade or

• business. See computational example below.

(b) IRC Section 179 Depreciation Election to Expense – For 2013, a taxpayer is allowed to elect to expense qualified assets up to $500,000. Note that this allowance is reduced dollar-for- dollar for every dollar of asset purchases in excess of $2,000,000. In addition, a taxpayer cannot use this expense if the expense is more than the amount of his/her taxable income earned from all trades or businesses. However, a taxpayer can include wages from another job as part of his/her income. The unused expense can be carried forward to future years. However, California only allows up to $25,000 of IRC Section 179 depreciation deductions.

• Extended through 2013 – certain qualified leasehold improvement property, qualified

restaurant property and qualified retail improvement property are eligible for Section 179 expensing up to $250,000. (c) Special (Bonus) Depreciation Allowance – in addition to the IRC 179 expense, a taxpayer can also take a deduction for bonus depreciation (after the IRC 179 expense is taken into consideration). The property must meet certain qualifications and must be a new asset (not previously used). However, California does not allow any special depreciation deductions.

• For 2013, the special depreciation allowance is 50%.

(d) Regular MACRS Depreciation – The remaining un-depreciated amount is subject to the standard regular depreciation for that year.

• First Year Depreciation. Generally, a taxpayer can claim a half-year's worth of

depreciation in the first year the asset is placed in service. It generally does not matter when the asset was placed in service.

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• A special rule applies when the cost of property placed in service in the last quarter of the

taxable year exceeds 40% of the total cost of property placed in service in the year. In this event, a taxpayer must depreciate all property as if it were acquired in the middle of whatever quarter it was acquired in, instead of mid-year.

• Extended through 2013 - depreciation deductions on leasehold improvements to

restaurants and retail space are deductible over 15-years straight-line rather than 39 years. (e) The California Section 179 amount continues to be limited to $25,000 and there is a $200,000 new purchase phase out threshold. California does not conform to bonus depreciation and Section 179 treatment of computer software.

• 2. Business Deductions

(a) Corporations that use the accrual method of accounting should pay bonuses and vacation pay (subject to limitations) related to the current year within two and one-half (2 ½) months after the close of the tax year. Otherwise, these expenses will not be deductible until actually paid. (b) Compensation to C corporation shareholders who own more than 50% and S corporation shareholders who own greater than 2% of the stock of a corporation must be paid by year-end in order to be deductible to the corporation. (c) A corporation has until the extended due date of its tax return to make deductible profit- sharing contributions for the previous tax year. (d) Businesses should look hard at any amounts owed to them that are no longer collectible. A bad debt deduction is available when there is an actual loss of money or when the business has already reported the amount as income (e.g. as an account receivable).

• Business bad debts can be written off even though it may only be partially worthless as

long as it can be identified with reasonable certainty. Reasonable efforts should be expended to collect the debt before it is written off.

• 3. Partner Expenses. Partners can deduct unreimbursed out-of-pocket business expenses including

automobile costs, travel and meal expenses on their individual returns as a reduction in their partnership income. These expenses are not subject to the 2% of AGI floor that applies to employee business expenses. An individual partner can deduct unreimbursed partnership expenses paid for actual partnership business expenses if required to pay these expenses under the partnership agreement.

• 4. Inventory Strategies

(a) If the business is an S corporation or a partnership, it may be possible to make a charitable deduction of inventory by year-end and pass the deduction through to the partners or shareholders for reporting on their individual return. (b) A review of inventory should be done to determine if any items can be written down or written off. In order to claim the write-off of obsolete inventory, the item should be offered for sale within 30 days after the inventory date, at the marked-down price.

25

• 5. S Corporation and Partnerships.

(a) If either a partnership or an S corporation expects to generate a loss in 2013, be advised that you must have sufficient tax basis before you can deduct that loss. (b) For tax year 2013, the failure to file a partnership (Form 1065) or an S corporation (Form 1120S) tax return on a timely manner will result in a penalty of $195 per partner or shareholder per month up to a maximum of 12 months. This penalty is assessed against the partnership or corporation. The penalty may not be imposed if the partnership or corporation can show the failure was due to reasonable cause.

• 6. Net Operating Loss (NOL).

(a) 2013 federal NOLs are eligible to be carried back 2 years and forward 20 years. (b) California NOLs –

• For 2013, NOL carryover deductions can be used.
• For tax years beginning January 1, 2013, NOLs can once again be carried back 2-years;

under the following limitations:

• 50% of NOLs generated in the 2013 tax year;
• 75% of NOLs generated in the 2014 tax year; and
• 100% of NOLs generated in the 2015 tax year.

(c) An election is available to forego the carryback period and carry the NOL forward.

• 7. Miscellaneous Business Items.

(a) Limited Liability Company (LLC).

• Payment of LLC Fees – The estimated California annual LLC fee (referred to as the gross

income fee) is due by June 15th.

• For 2014, the LLC annual tax of $800 is due April 15, 2014.
• XVIII. Estimated Tax Payments
• 1. Federal.

(a) Individuals are subject to an underpayment penalty unless 100% of the prior year’s taxes are paid in through withholding and estimated payments (safe harbor rule), or 90% of the current year tax liability reported on their return. If the prior year's AGI is over $150,000, the safe harbor is 110% of prior year's tax. (b) Estimated tax payments are credited on the date they are actually made. On the other hand, withholding is deemed to be done pro-rata throughout the year. If a taxpayer is expecting a large Christmas bonus and is underpaid for the purposes of estimated tax, he or she might consider having a large portion of the payment go to the government as withholding.

26 (c) Taxpayers will not be subject to the underpayment penalty if (1) the tax due after subtracting withholding is less than $1,000 or (2) was a U.S. citizen or resident and had no tax liability

• n their prior year’s tax return that covered 12 months.

(d) If income varies considerably during 2013, taxpayers should consider “annualizing” their income which can reduce or eliminate an estimated tax penalty.

• 2. California.

(a) 2013 and 2014 - Individual Estimated Tax Payments.

• First Installment - 30% of estimated tax.
• Second Installment - 40% of estimated tax.
• Third Installment - 0% of estimated tax.
• Fourth Installment - 30% of estimated tax.
• Individual taxpayers with California adjusted gross income equal to or greater than $1

million ($500,000 for MFS) must pay 90% of the current-year tax, or be subject to the underpayment of estimated tax penalty.

• Estimated tax payments or payments with extension requests made electronically - The

new California state law requires individuals to remit all future payments electronically

• nce they make an estimated tax or extension state payment (by check or electronic

method) over $20,000 for a taxable year beginning on or after January 1, 2009; or file an

• riginal return with a tax liability over $80,000 for a taxable year beginning on or after

January 1, 2009. (b) 2013 and 2014 - Corporate Estimate Tax Payments.

• First Installment - greater of $800 or 30% of estimated tax.
• Second Installment - 40% of estimated tax less amount of first installment.
• Third Installment - 0% of estimated tax.
• Fourth Installment- 30% of estimated tax.
• XIX. Other Tax Credits
• 1. Non-business Energy Property Credit (Personal Energy Property Credit) – extended through

2013. (a) Taxpayers can claim a credit for certain home improvements placed in service in 2013, principal residence only. A credit equal to 10% of the cost of (1) qualified energy efficiency improvements, and (2) residential energy property expenditures. Other limits apply. A lifetime credit limit of $500 (with no more than $200 due to windows and skylights). (b) Qualifying property includes insulation systems that reduce heat loss/gain, exterior windows, exterior doors, metal and asphalt roofs, and biomass fuel stoves.

27

• 2. Residential Energy Efficient Property Credit.

a) Taxpayers can claim a credit of 30% of the cost for the installation of (1) qualified solar water heating property, (2) qualified solar electric property, (3) geothermal heat pumps, and (4) small wind energy property. The credit applies to property placed in service through December 31, 2016. b) There is no AGI limitation for the credit and the amount can be used to offset AMT.

• 3. American Opportunity Tax Credit (formerly known as the HOPE CREDIT) extended through

2017. (a) A taxpayer, spouse or dependent is enrolled in a post secondary educational program leading to a degree may be able to claim a credit for tuition and related expenses. (b) First four years of college. (c) The maximum credit is $2,500 per eligible student per year. (d) AGI phase out: $80,000 to $90,000 ($160,000 to $180,000 MFJ). (e) Up to 40% is refundable.

• 4. Research and development tax credit extended through 2013.
• 5. Minimum Tax Credit (MTC).

(a) MTC is available if the taxpayer paid alternative minimum tax generated by deferral items in a prior year. (b) Effective for tax years 2007 through 2012, taxpayers who have long-term unused AMT credits are allowed to claim a refundable credit. (this provision was not previously extended and expired for tax years beginning after December 31, 2012)

• XX. Other Items
• 1. Forgiveness of Home Mortgage Debt

(a) Debt forgiveness income not recognized in a foreclosure or mortgage workout. (b) Extended through December 31, 2013. (c) Applies only to principal residence, not second homes or rental property. (d) Debt incurred to acquire, construct or substantially improve the taxpayer’s principal residence. (e) Does not apply to taxpayers in Chapter 11 bankruptcy.

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• 2. FinCEN Report 114, Report of Foreign Bank and Financial Accounts (FBAR) – new form;

formerly Form TD F 90-22.1. (a) Purpose: FinCEN Report 114, Report of Foreign Bank and Financial Accounts, is used to report a financial interest in or signature authority over a foreign financial account. A United States person is not prohibited from owning foreign accounts. The FBAR is required because foreign financial institutions may not be subject to the same reporting requirements as domestic financial institutions. The FBAR is a tool to help the United States government identify persons who may be using foreign financial accounts to circumvent United States law. Investigators use FBARs to help identify or trace funds used for illicit purposes or to identify unreported income maintained or generated abroad. (b) Who Must File an FBAR: A United States person that has a financial interest in or signature authority over foreign financial accounts must file an FBAR if the aggregate value of the foreign financial accounts exceeds $10,000 at any time during the calendar year. (c) General Definitions:

• Financial Account: A financial account includes, but is not limited to, a securities,

brokerage, savings, demand, checking, deposit, time deposit, or other account maintained with a financial institution (or other person performing the services of a financial institution). A financial account also includes a commodity futures or options account, an insurance policy with a cash value (such as a whole life insurance policy), an annuity policy with a cash value, and shares in a mutual fund or similar pooled fund (i.e., a fund that is available to the general public with a regular net asset value determination and regular redemptions).

• Joint Account: A financial account type listed above owned jointly by two or more

persons.

• Foreign Financial Account: A foreign financial account is a financial account located
• utside of the United States. For example, an account maintained with a branch of a

United States bank that is physically located outside of the United States is a foreign financial account. An account maintained with a branch of a foreign bank that is physically located in the United States is not a foreign financial account.

• Financial Interest: A United States person has a financial interest in a foreign financial

account for which:

• 1. the United States person is the owner of record or holder of legal title, regardless
• f whether the account is maintained for the benefit of the United States person or

for the benefit of another person; or

• 2. the owner of record or holder of legal title is one of the following:
• An agent, nominee, attorney, or a person acting in some other capacity on

behalf of the United States person with respect to the account;

• A corporation in which the United States person owns directly or indirectly:

(i) more than 50 percent of the total value of shares of stock or (ii) more than 50 percent of the voting power of all shares of stock;

29

• A partnership in which the United States person owns directly or indirectly:

(i) an interest in more than 50 percent of the partnership's profits (e.g., distributive share of partnership income taking into account any special allocation agreement) or (ii) an interest in more than 50 percent of the partnership capital;

• A trust of which the United States person: (i) is the trust grantor and (ii) has

an ownership interest in the trust for United States federal tax purposes. See 26 U.S.C. sections 671-679 to determine if a grantor has an ownership interest in a trust;

• A trust in which the United States person has a greater than 50 percent

present beneficial interest in the assets or income of the trust for the calendar year; or

• Any other entity in which the United States person owns directly or

indirectly more than 50 percent of the voting power, total value of equity interest or assets, or interest in profits.

• Person: A person means an individual and legal entities including, but not limited to, a

limited liability company, corporation, partnership, trust, and estate.

• Signature Authority: Signature authority is the authority of an individual (alone or in

conjunction with another individual) to control the disposition of assets held in a foreign financial account by direct communication (whether in writing or otherwise) to the bank

• r other financial institution that maintains the financial account. See Exceptions,

Signature Authority.

• United States: For FBAR purposes, the United States includes the States, the District of

Columbia, all United States territories and possessions (e.g., American Samoa, the Commonwealth of the Northern Mariana Islands, the Commonwealth of Puerto Rico, Guam, and the United States Virgin Islands), and the Indian lands as defined in the Indian Gaming Regulatory Act. References to the laws of the United States include the laws of the United States federal government and the laws of all places listed in this definition.

• United States Person: United States person means United States citizens; United States

residents; entities, including but not limited to, corporations, partnerships, or limited liability companies created or organized in the United States or under the laws of the United States; and trusts or estates formed under the laws of the United States.

• United States Resident: A United States resident is an alien residing in the United States.

(d) Exceptions: There are some exceptions to the reporting requirements. See form instructions for a list and detailed information on the various exceptions. (e) Filing Information:

• When and Where to File: The FBAR is an annual report and must be filed on or before

June 30th of the year following the calendar year being reported. The FBAR must be filed electronically through FinCEN’s BSA E-Filing System (NEW REQUIREMENT). The application to file electronically is available at

30 http://bsaefiling.fincen.treas.gov/main.html, Filing Help Desk by calling 1-866-346-9478 (option 1) or via E-mail sent to BSAEFilingHelp@fincen.gov.

• No Extension of Time to File: Extensions of time to file federal tax returns do NOT

extend the time for filing an FBAR.

• Filing by Third Party Preparer: An FBARs may be completed and filed on behalf of the

filer and/or owner of the foreign account(s) by a third party preparer. The filer or owner who is using a third party preparer should complete and maintain a record of FinCEN Form 114a, FinCEN BSA E-Filing Signature Authorization Record, to authorize the third party filing. Do not file or send the completed Form 114a to FinCEN. Form 114a must be maintained by the filer or owner and made available to FinCEN or IRS on request. The third party preparer will complete FBAR Parts I through V and the Signature section using the following Item Instructions. NOTE: Spouses filing a joint FBAR also may use the Form 114a to approve/designate which spouse will sign the report. (f) Penalties: A person who is required to file an FBAR and fails to properly file may be subject to a civil penalty not to exceed $10,000 per violation. If there is reasonable cause for the failure and the balance in the account is properly reported, no penalty will be imposed. A person who willfully fails to report an account or account identifying information may be subject to a civil monetary penalty equal to the greater of $100,000 or 50 percent of the balance in the account at the time of the violation. See 31 U.S.C. section 5321(a)(5). Willful violations may also be subject to criminal penalties under 31 U.S.C. section 5322(a), 31 U.S.C. section 5322(b), or 18 U.S.C. section 1001.

• 3. Statement of Foreign Financial Assets – Filing of Form 8938; under the Foreign Account Tax

Compliance Act (FATCA). (a) Purpose: Use Form 8938 to report your specified foreign financial assets if the total value of all the specified foreign financial assets in which you have an interest is more than the appropriate reporting threshold. In addition to the FBAR reporting requirement discussed above, any “specified person” who has an interest in “specified foreign financial assets” at any time during the taxable year must file Form 8938 if the aggregate fair market value is more than the than the following thresholds:

• Unmarried or married filing separate living in the U.S.: More than $50,000 on the last

day of the year or $75,000 at any time during the year.

• Married living in the U.S.: More than $100,000 on the last day of the year or $150,000 at

any time during the year.

• Unmarried or married filing separate living abroad: More than $200,000 on the last day
• f the year or $300,000 at any time during the year.

31

• Married living abroad: More than $400,000 on the last day of the year or $600,000 at any

time during the year. (b) A “specified person” is a “specified individual” or a “specified domestic entity”:

• U.S. citizen; resident alien of the U.S. for any portion of the taxable year; nonresident

alien who makes the election to be treated as a resident alien in order to file a joint return with a U.S. citizen or resident spouse; or a nonresident alien who is a bona fide resident

• f American Samoa or Puerto Rico.
• Specified domestic entity includes domestic corporations, domestic partnership, or

certain trusts that are formed or availed for the purposes of holding, directly or indirectly, specified foreign financial assets. (c) The term “specified foreign financial asset” means:

• Financial accounts, for example

– Savings, checking and brokerage accounts held with a bank or broker-dealer.

• Investments not held in a foreign financial account, but issued by someone who is not a

U.S. person, any other interest in a foreign entity, and any financial instrument or contract held for investment with an issuer or counterparty that is not a U.S. person. Examples of items to be reported – Stock or securities issued by a foreign corporation (for example privately owned); – A note, bond or debenture issued by a foreign person; – A partnership interest in a foreign partnership; – An interest in a foreign retirement plan or deferred compensation plan; – An interest in a foreign estate; and – Any interest in a foreign-issued insurance contract or annuity with a cash-surrender value. – These examples listed above do not comprise an exclusive list of assets require to be reported.

• Other financial assets held for investment. An asset is held for investment if it is not used

in, or held for use in, the conduct of a trade or business of a specified person.

• Example of items not included:

– Foreign real estate, such as, a personal residence or a rental property does not have to be reported. If the real estate is held through a foreign entity, then the interest in the entity is a specified foreign financial asset. – Foreign currency directly held by taxpayer. – Foreign social security. – Foreign assets maintained by U.S. financial institution. – A financial account maintained by a U.S. branch or U.S. affiliate of a foreign financial institution does not have to be reported.

32 (d) Penalties:

• Penalty for failure to disclose is $10,000 up to $50,000.
• Form 8938 must be complete and correct, and filed by the due date of their income tax

return (including extension), otherwise a $10,000 penalty will be assessed.

• A 40% penalty of the amount of the underpayment of tax for failure to report the income

attributable to an undisclosed foreign financial asset.

• If the failure to report is shown to be due to reasonable cause and not due to willful

neglect, the penalty may be waived. (e) Statute of limitations:

• If a specified person fails to file Form 8938 or fails to report a specified foreign financial

asset, the statute of limitations for the tax year may remain open for all or part of the income tax return until three years after filing Form 8938. If the failure is due to reasonable cause, the statute of limitations remains open only with respect to the item or items related to the failure.

• If the amount of gross income attributable to assets required to be reported on Form 8938

is more than $5,000, the statute of limitations is six years after the return was filed.

• 4. 3.8% Net Investment Income Tax (NIIT).

(a) Starting 2013, the law imposes an additional surtax of 3.8% on net investment income (NII)

• n individuals, estates and trusts. The NIIT applies to U.S. citizens and residents. It does not

apply to nonresident aliens. (b) This new law will affect individual taxpayers whose modified adjusted gross income (MAGI) exceeds $250,000 for joint filers and surviving spouses, $200,000 for single and head of household filers, and $125,000 for married filing separately. To calculate your MAGI, take your adjusted gross income (AGI) from your tax return and add back any foreign earned income exclusion (if applicable). The threshold amounts are not indexed for inflation. (c) If the above thresholds apply, the 3.8% tax will apply to the lesser of (1) net investment income for the tax year or (2) the excess of MAGI over the threshold amount. For example –

• A married couple that has MAGI of $270,000 for 2013, of which $100,000 is net

investment income. MAGI $ 270,000 Threshold

• 250,000

Excess 20,000 Net investment income 100,000 Lesser of excess or NII 20,000 NIIT rate 3.8% Medicare contribution tax 760

33 (d) The proposed regulations specify that IRC §1411 applies to ordinary trusts described in Treasury Regulation §301.7701-4(a) whereas other trusts, such as exempt trusts, business trusts, and others, it does not apply. For estates and trusts, the tax is 3.8% of the lesser of:

• Undistributed net investment income; or
• The excess of AGI over the dollar amount at which the highest estate and trust income

tax bracket begins (for 2013 the highest bracket begins at $11,950 and $12,150 inflation adjusted for 2014). Trust Tax Planning Tip – if there is undistributed net investment income, consider a distribution if the beneficiary’s tax rate is lower than the trust since the threshold for the highest tax bracket is so much lower for trusts. Simple example – No Distribution $75,000 Distribution Gross Income $90,000 $90,000 Less: expenses (14,900) (14,900) Adjusted total income 75,100 75,100 Less: distribution deduction 75,000 Less: exemption (100) (100) Taxable income $75,000 $ 0 Trust income tax $28,058 $ 0 Beneficiary tax (assume 25%) 18,750 NIIT (* assume $0) 2,400 * Total Tax $30,458 $18,750 (e) Net investment income is investment income such as:

• Gross income from dividends, interest, annuities, royalties, and rents, less allocable

deductions unless these items are derived in the ordinary course of a trade or business to which the NIIT does not apply;

• Income derived from a trade or business treated as a passive activity, and a trade or

business of trading in financial instruments or commodities.

• Net taxable gain attributable to the disposition of property other than property held in a

trade or business to which the NIIT does not apply. (f) In arriving at net investment income, gross investment income is reduced by deductions that are properly allocable to items of gross investment income. (g) Items not included as investment income, for example:

• Tax-exempt bond interest;
• Veterans’ benefits;
• Amounts subject to self-employment taxes;
• Wages;

34

• Distributions from qualified retirement plans and IRAs; and
• Excludable gain from the sale of a principal residence.

(h) Distributions from qualified retirement plans are not subject to the tax, but the distributions may push your MAGI over the threshold that would cause other types of investment income to be subject to the 3.8% NIIT. (i) NIIT is calculated and reported on Form 8960, Net Investment Income Tax – Individuals, Estates, and Trusts. (j) For estimated tax payment purposes, the NIIT must be included in the calculation of estimated tax that you owe and may cause an underpayment penalty if you are not “safe harbor” protected for tax payments.

• 5. Additional Medicare Tax (HI).

(a) Starting 2013, the law imposes an additional 0.9% Medicare Hospital Insurance (HI) tax of 0.9% on wages, compensation, or self-employment income in excess of $250,000 for married filing joint filers, $125,000 for married filing separately, and $200,000 for all

• thers. The threshold amounts are not indexed for inflation.

This is in addition to the 1.45% Medicare tax that is currently imposed on earned income. The 0.9% tax applies only to employees and the self-employed; not to employers. (b) For joint filers, the additional tax applies to the combined wages of both spouses. For example, if a married couple earns combined wages of $300,000 in 2013; on a joint return they will pay an additional $450 ($300,000 combines wages - $250,000 threshold = $50,000 x 0.9% Medicare tax). (c) Once an employee’s wages reach $200,000 for the year, the employer must begin withholding the additional 0.9% tax from the employee’s wages. If the extra withholding is insufficient, the employee can request extra tax withholding by filing a new Form W-4 with the employer or make estimated tax payments. (d) Self-employment income is also subject to the extra 0.9% Medicare tax based on the same earned income thresholds provided above. While self-employed individuals can claim half

• f their self-employment tax as an income tax deduction (adjustment), the additional 0.9%

tax does not apply and won’t generate any income tax deduction. Self-employment losses cannot offset wages but, Self-employment losses may offset Self- employment income. (e) California – The additional Medicare tax on self-employment income is not deductible under current California law, there is no impact on California returns.

• 6. Same Sex Marriages. The IRS now recognizes same-sex marriages and as such, same-sex

couples that were legally married in jurisdictions that recognize their marriage will be treated as married for all federal tax purposes. The ruling (Revenue Ruling 2013-17) also holds that registered domestic partnerships (RDPs), civil unions or similar relationships recognized under state law will not be granted the same treatment and are therefore not considered married for federal tax purposes.

35 Boyd D. Hudson Attorney at Law Adams, Hawekotte & Hudson 251 South Lake Avenue, Suite 930 Pasadena, CA 91101-4873 Phone: 626-583-8000 x 209 Fax: 626-577-9400 Email: bdhlawyer@aol.com Charles G. Stanislawski, M.B.T., C.P.A. Stanislawski & Company, Inc. 729 Mission Street, Suite 100 South Pasadena, CA 91030 Phone: 626-441-0330 x 102 Fax: 626-441-3933 Email: chuck@stanislawskiandcompany.com