Tax Law Update
January 28, 2012
Andrew B. Martin, MS, CFE, CFF, CICA, CPA
Managing Partner
Martin & Associates, Ltd.
Overview
As readers of my writings understand, there are always some changes in the tax laws that govern our great country but there also seems to be shifts in attitudes of the Internal Revenue Service and those of the various state agencies. This year is no different.
It does appear that the IRS is becoming more aggressive and more difficult to deal with and much less taxpayer friendly. This is a huge disappointment for people who did not intend to violate the rules and truly a personal disappointment to us since in the end it makes the process of tax compliance more difficult.One area, for example, that the IRS is not dealing in the realm of reality is with respect to US Citizens who have foreign bank accounts. Referred to as Foreign Bank Account Reporting (FBAR) the IRS in the zeal to track down international money laundering has passed some new regulations that require extreme reporting requirements on taxpayers even if there is no income producing effect of the foreign assets. Folks, the penalties are severe so if you have an FBAR situation (i.e., you have ANY foreign bank accounts or other security holdings) you need to alert us immediately. Although there are efforts to reform the recent legislation to make it more fair and reasonable right now that is not the case. Beware.
In general, the IRS is stepping up enforcement, especially on non-profit organizations. The usual penalty there involves the IRS claims that the non-profit did not file its informational return on time (or extensions). So, although there is no tax involved (generally) and the form is for informational purposes only the penalties are in the severe range. Although we have had good success removing these penalties I believe it will become increasingly more difficult to do and will require more effort to do it (i.e., going to Appeals).
The “kinder and gentler” IRS is a myth and our advice to everyone is to understand that and work within the laws and expect no breaks for doing the right thing. As always, we stand ready to advise and assist but we also felt the need to point out the dramatic change in attitude that has been going on over the past few years with the IRS. The States are not much better. DC continues to be a major problem with respect to tax compliance and dealing honestly with taxpayers. Just getting through to the people making the decisions is extremely difficult. The cost of compliance therefore is going to increase and instead of encouraging taxpayers to come forward voluntarily when mistakes are made my belief is that the IRS and the States are pushing people away only making the job of tax compliance that much more difficult.
As a result of all of this, one service we have offered in the past, “the taxpayer advantage program” will no longer be offered effective with the 2011 filings. We will, of course, honor this program for the prior years. However, we will be available to assist with responding to the letters, notices and audits (and they are doing more of these too) such assistance will be at our standard hourly rates and might involve referrals to tax attorneys. Sorry for the bad news but I never believed in sugar coating anything when it comes to tax and tax compliance.
We all realize the IRS and the States have a job to do but they need to realize that most taxpayers, especially our clients, genuinely wish to be honest and do things correctly. As the IRS and the States desperately grab all the money possible from us, either in the form tax payments or penalties, the environment we are operating in can best be defined as toxic.
You have our personal commitment to help guide you through this and to honestly advise you on everything of concern. Furthermore, I have personally discussed the situation described above to various politicians and they assure me that our words are not falling on deaf ears. More as it develops.
Tax Rates Poised for Increase after 2012
I could get very political in this discussion but will try and refrain and let the readers draw their own conclusions and stick to some of the planning aspects that are relevant. Those of you who know me understand that I also am involved with politics so while the above is my goal I make no promises except to clearly indicate what are my opinions versus what are the facts and how to plan for them.
Tax Rates, Capital Gains and dividends rates and Reporting Issues
In general, the tax laws affecting your taxes in 2011 are pretty consistent with years past. Tax rates are the same for all filing statuses with only minor inflation adjustments. Long term capital gains (LTCG) rates remain at 15% for the majority of taxpayers and will stay at this level through Dec 31, 2012. As of now, the LTCG rate is set to increase to 20% after that date. Same for qualified dividends. However, starting in 2013, there will be potential tax surcharges if adjusted gross income exceeds $200,000 (single) and $250,000 (joint) in the form of a Medicare surcharge (an additional 3.2%). So, for some of you the LTCG rate and tax on qualified dividends in 2013 will effectively rise to 23.2% (versus the current 15%).
Basic planning strategy would involve recognizing long term capital gains prior to 2013 as well as for some people paying dividends in their closely held businesses before that time as well. Additionally, if you are thinking about an installment sale (one that involves the sale of a capital asset such as an investment property and takes place over a period of a few years or more) you might want to accelerate the income recognition into 2012.
The IRS is also now requiring all brokerage firms to provide cost basis information on their 1099-B reporting. Many already do this but this is seen as an example of additional compliance requirements and one wonders if the IRS will now also have the cost basis information and start matching things up with even more scrutiny. One bit of good news, for those of you who have dabbled in the market in the area of short sales, the IRS has changed the reporting on these which should actually make it easier to comply (there, I said something nice!) Formerly, all sales, long or short were reported when they occurred but now short sales will only be reported when the transaction is complete, frequently that will mean in the following year. At least this makes better sense and should help the compliance efforts in general. The number one reason that holds us up when preparing tax returns is the lack of cost basis information for stocks sold. Please be aware of this and work with us in advance to gather this information. In our tax organizer you will find a Schedule D reporting form for you to list any stock trades or attach the brokerage forms you receive.
Of course, in my next breath I will also tell you that the IRS has developed a new form (8949) that replaces the old form D-1. For those of you who have many stock trades and for those of you who have multiple accounts, the reporting is getting more involved. If you are in this situation please expect a fee increase in our services given the extra work now required. We urge you to consider simplifying your investment strategy if possible. Why the IRS is doing this is not readily apparent except to possibly make their life easier when matching up the stock sales. There are even more rule changes related to the reporting of stock sales which we can discuss as they become relevant to your situation. The longed for tax simplification is not happening anytime soon.
FICA Wage Base, Foreign Earned Income Issues and More FBAR
Once again the onerous FICA tax gets an increase with respect to the wage base increasing from $106,800 in 2011 to $110,100 in 2012.
At least after weeks of legal wrangling at taxpayer expense, the US Congress last week decided to extend the infamous payroll tax cut of 2% for at least 2 months. The Republicans were (and will again) trying to hold this very important tax cut hostage in an effort to get the Democrats to agree to the Keystone Pipeline project. Still, for the average US taxpayer the savings are significant and amount to about $1,000 per year. Now if we can only get the US Government to repay the trillions of dollars removed from the social security fund to cover up the deficits we would actually be making progress towards stabilizing the long term outlook for social security and the intended recipients (us!) Hopefully, we will see a continuation of a long term plan to reduce this regressive tax (meaning the tax hits harder on people who do not earn as much).
Foreign Earned Income Exclusion
We receive a lot of questions about this. Essentially, if you are working overseas for the entire year (and not for the US Government) you are probably entitled to exclude up to $92,900 of your wage income. If you are in this situation, you will want to read IRS Publication 4732. This can be found on the IRS website at www.IRS.gov.
One issue we would like to clear up in this article is the subject of the self employment tax as it relates to foreign earned income. There is a subtle rule affecting this. IF you are employed by a US employer and located overseas you are probably having social security and Medicare taxes withheld so there is no issue. The fun part comes when you are working for a foreign employer overseas. Under this scenario, as long as you are an employee you are not subject to the self employment taxes even though social security and Medicare is not being withheld (or paid for by your foreign employer). You will owe the self employment taxes IF you are an independent contractor. Although your earnings might be exempt from income tax you will still be subject to self employment taxes. Ugly but true. So, if you have the opportunity to negotiate your status, choose to be an employee of the foreign entity. Of course, there could be local, in country rules that affect that decision so be sure to get competent advice in the country that you choose to work in.
FBAR (Foreign Bank Account Reporting)
I touched on this in the overview section so will not dwell on it again here except to say that if you fall under this rule (having a foreign bank account generally makes you fall under this rule…) you need to alert us and plan on completing a TD F90-22.1 (we do not complete this for you but can review what you fill in) by June 30 of each year (we are recommending this regardless if your balance is over or under the $10,000 threshold to be safe) as well as making sure we check the appropriate box on Schedule B on your tax returns.
The penalties for non compliance, regardless of how much sense they do not make, are overbearing and unreasonable. The best approach is to make sure you do not get out of compliance.
The IRS on its website has an extensive frequently asked questions (FAQ) posting on this subject so if this shoe fits we recommend you reviewing it.
This is not so much an income situation but rather an asset value situation. Hopefully the recent laws that passed will be rewritten to make sense.
Itemized Deductions, mileage rates and yet another warning
Some of you might recall that in the past if your Adjusted Gross Income (AGI) exceeded a certain threshold your itemized deductions were “phased out”. Under the tax laws passed for 2011 the “phase outs” no longer are a factor. For 2012, we also appear safe from the old phase out rules. However, as the Federal Government struggles to pay its bills the expectation is that the phase out rules will resurface in 2013 and beyond.
Specific itemized deductions are also under attack. Starting in 2013 the medical expense deduction will only be available if the total medical expenses exceed a whopping 10% of AGI (up from 7.5% currently which is up from 5% from several years ago). More people will probably want to seek out health savings accounts (HSAs) if available through their employers since this allows for medical expenses to be paid effectively before taxes are levied on wages. Of course, there are rules to consider so definitely meet with your plan administrators to gain a better understanding of whether this is right for you and or your family.
As far as we know the sales tax deduction is gone after 2011. This tax deduction has a rich history; it literally comes and goes with no real predictor. Our position is that this is a tax imposed by a state and is regressive by its nature and should be deductible. The current law is adequate which allows for the claiming of either state income taxes paid or sales taxes paid, whichever is greater. Obviously the law change after 2011 is not advantageous to residents of states, such as Nevada, which have no income tax. Of course, these same people are not as affected by the dreaded and highly illogical alternative minimum tax (AMT).
Mileage rates for business, medical and charitable use of vehicle
Many people ask about this so here is the simple answer (and what is simple when it comes to tax anyway?) For the period of Jan 1 – June 30, 2011, the allowable rate per mile was 51 cents. For the period of July 1 – December 31, 2011 the rate increased to 55.5 cents. Hopefully your records are in good shape to help you determine how much mileage applies to whichever period of time.
Medical mileage is also deductible (granted subject to the very high threshold mentioned previously). The rate allowable also has a split year at 19 cents and 23.5 cents respectively.
Miles driven on behalf of a charity are deductible at a constant rate of 14 cents for the entire 2011 tax year.
There are more detailed rules on this but we can review with you as your situation requires.
Mortgage Interest Deduction
If ever there were a favorite deduction in the tax code this one probably is it. The Government has long used tax policy to influence the private marketplace and the deduction allowable for home mortgage interest (but not rent!) demonstrates this. The theory being is that if people own homes they will go out and purchase heavy consumer durables (washing machines, refrigerators, etc) which help spur on production and, likewise, our economy. But there are limits to this deduction that most people are not aware of.
If you plan on claiming more than $60,000 of mortgage interest you are probably guaranteeing an audit!
The rule is that you cannot claim mortgage interest on a primary (and 2nd) residence on an excess of $1,000,000 of mortgage indebtedness and $100,000 of home equity loans. So, the IRS is figuring that most interest rates paid are under 6% so hence the amount listed above. Limits are based per house and not person but a person can own two homes that qualify for deduction.
The IRS is also cracking down on this deduction in general so be careful. Again, the kinder and gentler IRS is gone. Confused? You know what to do, speak to us.
Charitable Contributions
This is another hot button area. In general the documentation requirements are increasing, especially on deductions greater than $5,000 involving noncash items. If you are in the situation remember to get certified appraisals and maintain as much documentation on what you donate.
Even if the amounts deducted are below $5,000 please maintain your receipts. Also recall that if you donate a vehicle the organization you donate it to will need to provide you the appropriate deduction value based upon the amount the vehicle sold for at its auction or other sale. Gone are the days of rolling cars into Goodwill (or wherever) and claiming the “Blue Book” value. Granted, that was clearly wrong to do but the pendulum has gone the full other direction on this deduction and it is hard to claim, especially if the “value” being claimed is over $5,000.
Tax Credits
This section is not meant to be a complete discussion about available credits but rather a concise summary of the more popular ones.
Adoption Credit
Good to see this credit alive and well in the tax code. If you qualify (speak to us…) you can claim a credit for your actual expenses up to $13,360 for 2011. This is reportable on form 8839 which, unfortunately, will require us to have you file your tax returns via paper and “snail mail” since it is not supported at this time for electronic filing. Naturally, the return will receive more scrutiny given the amount of the credit but if you are entitled to it the really good news is that the IRS will also allow it to be “refundable”. “Refundable” means that even if your tax bill is less than available credit allowed you will still get the difference. For example, if your total tax bill was $10,000 and you qualify for a $13,360 credit you get the entire amount back in your tax refund. Certainly some social engineering going on here to encourage adoption which is probably a good thing given the cost of children and eventual college expenses.
There are special rules for foreign adoptions so if you are planning a foreign adoption please alert us so we can discuss the details.
Education Credit
This credit was extended through Dec 31, 2012 and is even 40% refundable. AGI limits apply but certainly give us the information when we prepare your returns and if you qualify we will let you know.
Energy Credit
For all the talk in Washington about encouraging people to do the right thing and replace their outdated appliances, fix their windows and doors and otherwise reduce their energy consumption, this credit is extremely limited (now $500). If you have previously claimed the $1500 credit you may not claim an additional credit this year. Worst yet if you have no tax liability the credit is lost. This does not apply to solar credits (extended through Dec 31, 2016) or electric vehicles.
Electric Vehicles
If you are considering owning a Chevy Volt, Tessa or Nissan Cube you may qualify for up to $7,500 in tax credits. Additional credits are available for installing the appropriate charging station in your home (30% of the cost).
Conclusions
In this article I have tried to cover some of the highlights of the tax law revisions and regulations made by Congress and the IRS. It is by no means inclusive of all of the items that could have been included and you are urged to discuss your specific situation with us so we can determine the correct course of action for you.
As has been a main thread of discussion in this article is the fact that the IRS is getting tougher to deal with and enacting rules that are less favorable to taxpayers. Although there has been some backlash on some of their proposed rules, like the one that would have required all people who rent property to issue 1099s to all vendors, we expect that there will be more audits accordingly so the need to keep good records increases.
Some of the rules are not rationale, such as the new rule requiring people who have self employed businesses (Schedule C and you know who you are..) to report how much they receive from credit card payments (after 1/1/12) (a new form has been developed for this reporting.. a 1099-K) as well as other payments (1099-Misc), and ultimately will probably be modified or eliminated.
I have had a chance to review some of the new tax forms for 2011, such as Schedule C & Schedule E. I have noticed increased reporting requirements as discussed above but want to emphasize the point that there is an undercurrent that the IRS wants more details and more specifics. For example, on Schedule E (rental property) they now want to know what type of property is being rented and, in some cases, exactly how many days it was rented (versus not rented). Additionally, although the IRS has backed off of the strict 1099 reporting requirements initially proposed there is now, on the face of Schedule E, several disclosure questions relating to the taxpayer’s need to issue 1099s etc. Clearly, they are gathering more information via disclosure than they did in the past. This will push up the cost of compliance (which means we will be potentially taking longer to prepare your tax returns hence increasing the preparation cost (sorry)). We have also noticed similar additional disclosures on the newly revised Schedule C (Self employment).
Other rules remain very confusing, such as what happens when you sell your primary residence and it might have been used as a rental property. For example, there is a huge difference if you rent your residence after qualifying for the capital gains exclusion ($250k for single, $500k for joint ownership) versus converting your rental property into a primary residence (the opposite situation but handled completely differently under the tax laws).
Your best take away from this is that if anything has changed in your particular circumstances; please let us know about it so we can advise. Of course it would be best for us to know before you make any decisions. Please know that I only recommend engaging us for tax planning etc. if there is a value added to you. It is best to know what you are dealing with before it deals with you…..
Finally, thanks for reading all the way through this and I hope you found it interesting. My goal is to generally create issue awareness rather than providing specific answers to specific situations. Likewise, seek competent tax counsel for your needs and do not rely solely upon this article for advice as I will disclaim any responsibility.
In the coming weeks please gather your information, review and complete the tax organizer located on my website at www.MartinLtd.com and contact us for an appointment. Always best to get in early. Most of you should be ready by the beginning of February.
Please also note that our DC office number has changed and is now 202-332-4440. Our Las Vegas office number is 702-889-3566.
I am personally grateful for all of your trust and confidence over the years and look forward to assisting you again this coming tax season.