Planning for Taxes in an Uncertain Environment

1. Planning for Taxes in an Uncertain Environment James F. Knight, CPA

2. “This is a question too difficult for a mathmatician. It should be asked of a philosopher”. • Albert Einstein, about filling out his tax form in 1944

3. What we’ll talk about • Expiration of President Bush’s 2001 & 2003 tax cuts • Immediate(1/1/13) impact of the Patient Protection and Affordable Care Act (PPACA) & Health Care and Education Reconciliation Act of 2010 (HCERA) • Long-term implementation of PPACA & HCERA

4. Expiration of Bush tax cuts • Originally extended in December of 2010 • Set to expire December 31, 2012 • Political uncertainty vs. conventional wisdom

5. Expiration of Bush tax cuts • Some key notable changes include; • Top rates increase from 33% to 36% and from 35% to 39.6% • Top long-term capital gains tax rate will increase from 15% to 20% • Qualified dividends will no longer be subject to preferred tax rate of 15%. They will be subject to ordinary tax rates.

6. Expiration of Bush tax cuts • Some key notable changes include; • Itemized deductions will again be phased out by the lesser of (a) 3% of the excess of adjusted gross income over an applicable amount or (b) 80% of the amount of the itemized deductions otherwise allowable for such taxable year.

7. Expiration of Bush tax cuts • Some key notable changes include; • Estate, gift and generation-skipping transfer tax exemptions will be reduced from $5.12 million to $1million and maximum transfer rates will increase from 35% to 55%

8. 2013 Impact of PPACA • Key Provision • Addition of FICA Hospital Insurance Payroll Tax • High-income earners will be subject to an additional payroll tax of 0.9% on wages received in excess of the following threshold amounts; • Married filing jointly - $250,000 • Married filing separately -$125,000 • Single or head-of-household - $200,000

9. 2013 Impact of PPACA • Addition of FICA Hospital Insurance Payroll Tax • FICA (Federal Insurance Contributions Act) • Social Security portion (4.2% of wages up to $110,000) • Medicare portion (1.45% on all wages) • Employer “match” -6.2% SS, 1.45% Medicare • New 0.9% added to Medicare tax on wages earned in excess of the applicable threshold amounts for a combined employee Medicare rate of 2.35%

10. Addition of FICA Hospital Insurance Payroll Tax • The additional tax applies to wages and self-employment income • It will not be adjusted for inflation • It will not qualify for the above-the-line deduction for 50% of SE tax. • Need to be considered for estimated tax purposes.

11. Addition of the 3.8% Medicare Contribution Tax • Beginning in 2013, a new 3.8% Medicare tax will be imposed on certain unearned income of individual, trusts, and estates. • This tax is in addition to any other income taxes a taxpayer may owe.

12. Addition of the 3.8% Medicare Contribution Tax • For individuals, the tax is calculated by multiplying the 3.8% rate by the LESSER of; • Net investment income for the year, or • Modified adjusted gross income (MAGI) exceed the threshold amount

13. Addition of the 3.8% Medicare Contribution Tax • Net investment income is unearned income including; • Interest, dividends, capital gains • Annuities, rents and royalties • Passive income from a business • Net gain on the sale of a principal residence in excess of the current exclusion amounts • Gain on the disposition of passive activity property

14. Addition of the 3.8% Medicare Contribution Tax • Net investment income does NOT include; • Pension, IRA, Profit sharing plan distributions • Tax-exempt income • Income subject to self-employment tax • Royalties from oil and gas production, with exceptions

15. Addition of the 3.8% Medicare Contribution Tax • Lessor of Net investment income or MAGI over the threshold amounts; • Married filing jointly - $250,000 • Married filing separately - $125,000 • Single or head-of-household - $200,000

16. Addition of the 3.8% Medicare Contribution Tax • If a taxpayer has net investment income but their MAGI is below the threshold amounts, they will not be subject to the tax • If a taxpayer has MAGI above the threshold but has no net investment income, they will not be subject to the tax.

17. Addition of the 3.8% Medicare Contribution Tax • Example • Harry and Teri, a married couple filing a joint return, have 2013 MAGI of $350,000 and $60,000 of net investment income. • They will owe 3.8% medicare contribution tax on $60,000 or $2,280.

18. Addition of the 3.8% Medicare Contribution Tax • The MC tax also applies to estates and trusts. • 3.8% applies to the lesser of (a) the undistributed net investment income or (b) the AGI over the amount at which the highest trust and estate tax bracket begins • Over $11,650 for 2012 • Tax doesn’t apply to trusts that don’t have undistributed income (simple trusts)

19. Combined effect on tax rates

20. Strategies in anticipation of higher rates • Accelerate income • Bonuses, commissions • Convert to a ROTH in 2012 • Not subj to minimum distribution requirements • Consider exercising nonqualified stock options • Sell appreciated property prior to year end • Stocks, principal residence, other real estate

21. Strategies in anticipation of higher rates • Reset low basis positions • Wash sale rules don’t apply to gains

22. Strategies in anticipation of higher rates • Defer income • Increase retirement contributions • IRA contributions reduce MAGI and future distributions are not considered net investment income • 401(k) contributions reduce MAGI and wages subject to MC tax • Consider tax-deferred annuities • Life insurance-tax deferred growth free from current income tax and MC tax.

23. Strategies in anticipation of higher rates • Reduce income • Municipal bonds • Growth investments • Consider gifting assets that produce net investment income

24. Estate planning strategies • Take advantage of current $5.12 million exclusion • Important even if estate is not in $5 million range • Consider correcting gifting inequities • Trusts help keep control if beneficiaries not ready

25. Business planning • Expiration of bonus depreciation • Reduction of Sec. 179 limit • Current $139,000 with $560,000 investment ceiling • Drops to $25,000 with a $200,000 investment ceiling • Entity selection to reduce SE tax.

26. Other effects of the legislation • 2012 - Disclosure of health benefits on employees W-2 • Supposed to be effective in 2011 but mandator in 2012

27. Other effects of the legislation • 2013 • Medical expense threshold • Under 65 –increases to 10% of AGI • Over 65 -remains 7.5% • Fee imposed on health plans • $1 per covered person in 2013, $2 in 2014 • Maximum flexible spending provision for medical expenses capped at $2,500

28. Other effects of the legislation • 2014 • Premium assistance credit • Refundable credit for individuals with HH income between 100% and 400% of federal poverty level. • Excise Tax on Uninsured • New law requires citizens and legal residents to maintain minimum health insurance coverage. • Penalties will be greater of 2.5% of amount by which household income exceeds amount requiring filing of return or $695 per uninsured adult in household

29. Other effects of the legislation • Excise Tax on Uninsured(cont’d) • Individuals or employers will be offered a variety of optional coverage packages with different deductibles, copays, etc. but all offerings will meet federally mandated minimum coverage requirements. • Federal government will subsidize cost for those with relatively low income.

30. Other effects of the legislation • 2014 (cont’d) • Expanded employer/administrator reporting • “Qualified benefit” through exchange • Individual pays and claims credit or fed pays credit directly to the exchange and individual pays the difference. • Employer penalty • “applicable large employer” that fails to provide affordable “minimum essential coverage”

31. Questions/Comments • Thank you for being a valued friend of St. Clair CPAs