Income Taxes - PowerPoint PPT Presentation

income taxes n.
Download
Skip this Video
Loading SlideShow in 5 Seconds..
Income Taxes PowerPoint Presentation
Download Presentation
Income Taxes

play fullscreen
1 / 58
Income Taxes
322 Views
Download Presentation
jacob
Download Presentation

Income Taxes

- - - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript

  1. Income Taxes Presented by Robert Schwarzmann and Adam Polakov

  2. Agenda • Tax Landscape • Accounting for Income Taxes • Basics of Accruing Income Tax Expense • Deferred Taxes (ASC 740) • Footnote Disclosures and Valuation Allowance

  3. Tax Landscape • Expiration of Bush Tax Cuts • Patient Protection and Affordable Care Act • Election Year

  4. Bush Tax Cuts Sunset – 12/31/2012 • Marginal income tax rates return to pre-2001 levels

  5. Bush Tax Cuts Sunset – 12/31/2012 • Capital Gains tax rates will return to pre-2001 levels • Capital gains currently taxed 0 percent for taxpayers in the 10 and 15 percent brackets and at 15 percent for all others. • Will increase to 10 percent for taxpayers in 10 and 15 percent bracket and 20 percent for all others. • Qualified Dividends will be taxed as ordinary income • Qualified Dividends are currently taxed at the same rates as capital gains • Tax rate on Qualified Dividends increases to 43.4% with addition of 3.8% Investment Income Tax • The estate tax will be restored with an exemption level of $1 million and a top tax rate of 55% • Child care credit decreases to $500 from $1,000

  6. Bush Tax Cuts Sunset – 12/31/2012 • Return of the “marriage penalty” on jointly filed taxpayers • Joint filer’s standard deduction returns to 167% of individual standard deduction • End of accelerated “50% bonus” depreciation deductions • Section 179 expensing limitation - $25,000; $200,000 qualified asset additions (currently 125,000; 500,000) • The 2% FICA payroll tax cut is expiring • Alternative Minimum Tax (AMT) patch expires

  7. Affordable Care Act – New Taxes • Investment Income Tax • 3.8% Medicare Tax on Investment Income • Impacts individual taxpayers with AGI > $200,000 and joint filers with AGI > $250,000 • How does the Act define Investment Income • Dividend Income (Tax rate on Qualified Dividends increases to 43.4%) • Interest Income • Rental Income • Royalties • Short and Long Term Capital Gains • Passive Income from K-1’s where the taxpayer doesn’t materially participate • Gain from the sale of a primary residence (exceeding exclusions) • Gain from the sale of a 2nd home

  8. Affordable Care Act – New Taxes • Certain Income is exempt from the Act • Tax-exempt Income on municipal bonds and securities • Payouts from Regular or Roth IRAs • Payouts from 401(k) or pension • Social Security Income • Life Insurance Proceeds • Pass-through business income on which taxpayer is remitting Self Employment taxes

  9. Affordable Care Act – New Taxes • Computation • The new Medicare tax is computed as 3.8% on the lesser of • 1) Investment Income or • 2) the excess of AGI over the income threshold • Example 1 • A joint filer has $400,000 of AGI including $240,000 of W-2 wages and $160,000 of investment income • Because the excess of AGI over the income threshold ($400,000 -$250,000) of $150,000 is less than investment income of $160,000, the tax is based on excess AGI. • Additional Medicare tax is $5,700 ($150,000 x 3.8%)

  10. Affordable Care Act – New Taxes • Example 2 • A single filer has W-2 wages of $260,000 and dividend income of $100,000. AGI equals $360,000. • Because the excess of AGI over the income threshold ($360,000 - $200,000) of $160,000 is greater than investment income of $100,000, the tax is based on investment income. • Additional Medicare tax is $3,800 ($100,000 x 3.8%)

  11. Affordable Care Act – New Taxes • Example 3 • A single filer has $285,000 of income from the following sources: • IRA payouts of $80,000 • Social Security payments of $60,000 • Dividend income of $40,000 • Long Term Capital Gains of $30,000 • Tax Exempt interest income of $75,000 • AGI is $210,000 and Investment Income computed under the Act is $70,000 • Additional Medicare tax is $380 ($10,000 x 3.8%)

  12. Affordable Care Act – New Taxes • Example 4 • A joint filer purchased a home 30 years ago in New York City for $250,000 and sells it in 2013 for $2 million. The joint filer also has W-2 wages of $100,000. • Investment Income is $1,250,000 ($2 million less $250,000 cost basis less $500,000 exclusion) • AGI > $250,000 is $1,100,000 ($1,350,000 less $250,000 exclusion) • Additional Medicare tax is $41,800 ($1,100,000 x 3.8%)

  13. Affordable Care Act – New Taxes • Payroll Taxes • .9% Medicare Hospital Insurance Tax on Ordinary Income • Impacts individual taxpayers with Ordinary Income > $200,000 and joint filers with Ordinary Income > $250,000 • Assessed on the employee portion of Medicare • How does the Act define Ordinary Income? • W-2 wages • Pass-through business income on which taxpayer is remitting self employment taxes (Schedule K-1, Schedule C business income)

  14. Affordable Care Act – New Taxes • Withholding • Employers are required to withhold additional Medicare Tax • Employers are not required to consider a spouse’s wages or whether the employee earns wages at a second job • Because tax on “employee portion” of Medicare, self employed persons will not be able to deduct one half of this tax from AGI

  15. Affordable Care Act – New Taxes • Example • A joint filer earns $375,000 in W-2 wages and $150,000 of pass-through income from a business that is subject to self employment taxes • Ordinary Income subject to the .9% Medicare tax is $275,000 ($525,000 ordinary income less $250,000 exclusion) • Additional Medicare tax is $2,475 ($275,000 x .9%)

  16. Affordable Care Act – New Taxes • Medical Expenses • Itemized Deduction • The medical expense “floor” increases from 7.5% to 10% of AGI • (minimum amount of medical expenses that must be incurred before getting a tax deduction) • Healthcare Flexible Spending Account contributions limited to $2,500 (pre-tax) • Penalty for nonqualified distributions from Health Savings Accounts increases from 10% to 20%

  17. Mandatory Health Care Coverage • Effective January 1, 2014, large employers will be assessed excise tax penalties if any of the following are applicable: • Does not offer coverage for all full-time employees • Offers minimum essential coverage that is unaffordable (i.e., the employee contribution is > 9.5% of the employee’s household income) • Offers minimum essential coverage where the plan’s share of the total cost of benefits is less than 60% (Minimum essential coverage is defined as the large employer covering at least 60% of the cost.) • Any full-time employees are certified to have purchased health insurance through a state exchange and qualified for a tax credit

  18. Mandatory Health Care Coverage • Penalty if Employer does not offer a Health Care plan to all employees • An employer has 75 full time employees (FTE’s) and one employee is not covered by the group policy and the employee receives health coverage assistance • The tax would be based on 45 employees (75 FTEs less a 30 employee predefined minimum threshold) • For each month the employee is not covered, the tax is computed as follows: • 1/12 x $2,000 or $167/month per employee • 45 employees x $167 = $7,500 tax per month • Annual excise tax of $90,000

  19. Mandatory Health Care Coverage • Penalty if Employer offers Health Care coverage but does not meet certain criteria • Failure to offer all FTE’s the opportunity to enroll in minimum essential coverage under an eligible employer sponsored plan; and • At least 1 FTE has been certified as having enrolled in a state exchange plan and has received a premium tax credit • For example, minimum essential coverage is not met if at least one FTE receives a credit or cost sharing reduction in a state exchange plan because the employer’s premium under the health care plan exceeds 9.5% of that employee’s household income or the employer-offered plan pays for less than 60% of covered health care expenses • For each month the employee is not covered, the tax is computed as follows: • 1/12 x $3,000 or $250/month per employee • Penalty is capped at the penalty the employer would have owed had no health care plan been provided

  20. Individual Mandate • Effective January 1, 2014, all U.S. residents are required to maintain minimum essential coverage unless they meet one of the following exceptions: • Incarcerated individuals • Undocumented aliens • Individuals who meet certain hardship conditions and are unable to afford coverage • Individuals below the tax filing threshold • Members of Indian tribes

  21. Individual Mandate • Annual penalty for not having minimum essential coverage will be the greater of • A flat dollar amount or • $95 in 2014, $325 in 2015, and $695 in 2016 • A percentage of the individual’s taxable income over a certain threshold • Phased in at 1% in 2015, 2% in 2015, and 2.5% in 2016

  22. Other Provisions in the Act • Small Business Health Care Credit (2010-2013) • Credit is available up to 35% of health insurance premiums • Maximum eligibility for the credit is for employers with 10 or fewer workers with average wages of $25,000 or less

  23. Election Year Proposals • President Obama’s Tax Proposals • Set long term capital gains rate to 20% (Increases to 23.8% with the Medicare tax on investment income under the Affordable Care Act) • Reinstate the top two pre-2001 individual income tax rates (36% and 39.6%), but maintain Bush era tax rates for lower income taxpayers • Tax dividends at ordinary income tax rates

  24. Election Year Proposals • Establish limitations on the benefits of itemized deductions for higher income earners • Supports Federal Estate Tax of 45% with an exemption of $3.5 million • Repeal the Alternative Minimum Tax; Replace the AMT with the “Buffett Rule” which would institute a minimum 30% tax on taxpayers with an AGI > $1 million • Reduce the corporate tax rate from 35% to 28% while removing deductions/loopholes embedded in the tax code

  25. Election Year Proposals • Governor Romney’s Tax Proposals • Repeal the 3.8% Medicare tax on Investment income embedded in the Affordable Care Act • Reduce the tax rate on long term capital gains, dividend income and interest income rate to zero for all taxpayers with AGI below $200,000 • Maintain a 15% rate on capital gains and qualified dividends for taxpayers with AGI > $200,000 • Permanent, across-the-board 20% tax cut on all individual income tax rates

  26. Election Year Proposals • Governor Romney’s Tax Proposals cont’d • Repeal the Alternative Minimum Tax • Eliminate the Federal Estate Tax • Reduce the corporate tax rate from 35% to 28% while removing deductions/loopholes embedded in the tax code • Supports transitioning our Corporate Tax to a Territorial tax system

  27. Accounting for Income Taxes • Definitions • Basics of Income Tax Expense Accrual • Deferred Tax Components • Balance Sheet Approach vs. Expense • Footnote Disclosure • Valuation Allowance

  28. Accounting for Income Taxes • Definitions • Income Tax Expense – tax expense recorded on Income Statement • Current Tax Expense/(Benefit) – amounts owed to (or due from) federal and state tax authorities that must be paid currently • Deferred Tax Expense/(Benefit) – amounts owed to (or due from) federal and state authorities but not yet paid or received • Income Tax (Payable)/Receivable – current income tax liability or receivable recorded on balance sheet • Deferred Tax Asset/(Liability) – an asset/liability on a company’s balance sheet that may be used to reduce (or increase) a subsequent period’s income tax payable

  29. Accounting for Income Taxes • Basics of Accruing Tax Expense • Pre-tax book income (GAAP) • Adjust for Permanent Items • Examples of permanent tax adjustments (M-3’s) • Tax exempt interest income • Fines & Penalties • Social Club Dues • Meals & Entertainment • Federal income tax expense • APB 11 (Income Statement) Approach • Pre-tax income + Perm M-3s x blended rate = tax expense

  30. Accounting for Income Taxes • Using a Blended Tax Rate: • 34% + 6% x (1-.34) = 37.96% for GA corporations

  31. Accounting for Income Taxes • In a multi-state environment the blended rate can get much more complicated • When state apportionment formulas are computed each year, the rate can fluctuate based on the individual state activity • Calculating state tax expense under APB 11: • NC: 70% apportionment x 6.9% tax rate = .0483 • GA: 30% apportionment x 6.0% tax rate = .018 • .018 + .0483 = 6.63% blended APB 11 state tax rate • Blended rate = .34 + 6.63% x (1- .34) = 38.45

  32. Accounting for Income Taxes • Effective Tax Rate (ETR) • Expected ETR = tax expense / pre-tax book income • What is the impact of an increase in tax-exempt income? • What is the impact of an increase in social club dues? • ETR may fluctuate even if Permanent M-3s are consistent • Timing differences do NOT impact the ETR • Differs from Statutory tax rate (34%)

  33. Accounting for Income Taxes • How to reflect on books • Tax is similar to other accrued expenses • Debit expense, credit tax reserve account • Payments exceeding accrual create prepaid • Monitor the balance in the reserve account by tracking current tax position (accruals vs. estimated payments) as well as deferred tax balances (supported by components of deferred tax)

  34. Accounting for Income Taxes • Making Tax Payments • Estimated Payments • Due 4 times each year • Final Extension payment for prior year • Due March 15 • Payment with return • If necessary • Refunds and Overpayments • Represent receivable on balance sheet

  35. Accounting for Income Taxes • Payment v. Accrual • Why are they different? • Examples of Temporary Items of Tax Adjustment (M-3’s) • Bad Debt Reserve • Fixed Asset Depreciation • Accruals for Deferred Compensation • Accruals for Contingencies • Why are they Temporary? • Each item of income or expense is the same for book & tax over time

  36. ASC 740 Deferred Taxes • ASC 740 Balance Sheet Approach to Taxes • Timing differences between book basis and tax basis • Does not impact total tax expense or ETR • Recognizing deferred tax assets and liabilities • Taxable Temporary Differences • Deferred Tax Liability (DTL) • Book Basis > Tax Basis; Future Taxable income • Deductible Temporary Differences • Deferred Tax Asset (DTA) • Book Basis < Tax Basis; Future Taxable Expense

  37. Deferred Tax Liability Example • Fixed asset depreciation • Furniture costs $20,000 • Book depreciates over 10 yrs straight line - $2,000 • Tax depreciates over 7 yrs w/50% bonus – $11,429 • Favorable Tax adjustment = $9,429 • Reduces taxable income in current period • Book basis = $18,000 Tax basis = $8,571 • Deferred component = ($9,429) • Book Basis > Tax Basis = Deferred Tax Liability • Future taxable income upon reversal

  38. Deferred Tax Asset Example • Bad Debt Reserve • Initial reserve for books is $2,000,000 • Allowed reserve for tax is $150,000 • Unfavorable Tax adjustment = $1,850,000 • disallowed deduction (or additional income) • Deferred component = $1,850,000 • Book Reserve > Tax Reserve = Deferred Tax Asset

  39. Deferred Tax Inventory • Fixed Assets (9,429) • Bad Debt Reserve 1,850,000 • Total Timing Differences 1,840,571 • Tax rate 37.96% • Deferred Tax Asset (rounded) 700,000 • Reported on the footnote of the company’s audited financial statements

  40. Example – Accruing Tax Expense

  41. Accruing Tax Expense Under APB 11

  42. Accruing Tax Expense under ASC 740

  43. Footnote Disclosures • Components of ASC 740 current year tax expense • Current & Deferred (current / non-current) • Federal & State • Rate Reconciliation (a recon between the statutory rate and the effective tax rate) • Remember: Perm Differences only! • Deferred tax inventory • Tax effected {37.96%}

  44. Disclosure: ASC 740 Components of expense

  45. Current Income Tax Expense

  46. Disclosure: Rate Reconciliation

  47. Disclosure: Deferred Tax Inventory

  48. Cushion or Excess Reserves • A cumulative over or (under) accrual of income tax expense • Unallocated tax liability on the balance sheet • Additional tax expense to cover exposure or risky tax positions • ASC 740 does NOT provide for any excess tax reserve that cannot be supported by a book/tax basis difference • Materiality (audit standards)

  49. Valuation Allowance – GAAP • Should a valuation allowance against the corporation’s deferred tax asset be booked for GAAP? • Is it “More likely than Not” (greater than 50%), after evaluating all available evidence, that the deferred tax asset will not be realized? • Requires significant judgment in evaluating negative and positive evidence

  50. Valuation Allowance – GAAP • Negative Evidence - objective and verifiable • Cumulative losses over past 3 yrs – very difficult to conclude a valuation allowance is not needed • Large net operating loss carry forward amounts • Tax is 20 yrs; GAAP looks at a much shorter timeframe • No carry-back capacity • Expiring credits • Capital losses with no capital gains • Future income in jeopardy • Going Concern opinion in the audited financial statements.