Fiscal Cliff Update

As we near the end of the year, there are a large number of things still in flux, mostly related to the so-called “Fiscal Cliff” of tax increases and spending cuts.  Congress and the President are negotiating to avoid the Cliff, since most believe allowing the country to “go over” would push the economy back into recession.

What does this mean to you, you might ask?  Below is a list of the benefits that are already expired for 2012 (or will expire at the end of this year) unless Congress acts to reinstate them.  This is just a partial list of the items most likely to effect the average taxpayer.

  • The 10% tax bracket for the lowest income Americans moves to 15%.
  • The highest tax bracket will move from 35% to 39.6%
  • Interest and dividends will be taxed at ordinary income tax rates, rather than a maximum tax rate of 15%
  • Capital gains will be taxed at a maximum of 20%, rather than the current maximum of 15%.
  • Nearly 26 million more Americans will pay the “Alternative Minimum Tax” or AMT, which eliminates many tax deductions otherwise available and uses only two tax rates – 26% and 28% – to calculate Federal tax.
  • Adoption benefits provided by employers to assist employees with the cost of adoption will no longer be excluded from taxable income.
  • Tax-free tuition assistance provided by employers to their employees of up to $5,250 will not be allowed.
  • The 2% reduction of the employee’s portion of Social Security will expire, essentially reducing take-home pay by 2% for those earning up to $113,700.
  • The up-to $4,000 deduction for tuition and fees will not be allowed.
  • Mortgage insurance premiums will no longer be allowed as a deduction.
  • State and local sales taxes will not be allowed as a deduction in place of state and local income taxes, a provision that effects mostly those in states with no state income tax.

We’ll keep an eye toward Washington, and when there is a resolution to the Fiscal Cliff questions, we’ll bring you a full explanation.

2013 Tax Planning Tips

If current law is allowed to continue into 2013 unchanged,  most taxpayers will face higher tax rates on investment income like interest and dividends, and if the Bush-Era tax cuts are allowed to expire, many will pay higher taxes on ordinary income like salaries and business profits as well.  The question for many is how to avoid paying these higher rates to the extent possible.  Below are a few tips.

  • If you are considering selling a capital asset next year, like a rental property or appreciated stock, consider selling it at the end of 2011 instead to lock in the lower tax rates.
  • If you are considering converting a traditional IRA to a Roth, do it this year to take advantage of the lower rates.  Also, when you take money out of the Roth account, it won’t reflect in your income when determining if you are subject to the 3.8% Medicare surtax on investment income, so you might avoid paying it altogether. Distributions from traditional IRA’s will be.
  • To the extent you can, accelerate income into 2012 to avoid the possibility of paying a higher rate on it come 2013.

The picture is clear: either rates will stay the same or go up; there aren’t many that believe taxes will decrease next year.  As always, we’re here to help navigate the process.

Using Corporate Funds Correctly

Businesses that chose to organize as a corporation do so for many reasons. Chief among these is to protect the owners and their assets from liability arising from the actions of the business or its employees. This is accomplished because a corporation is an “artificial person” in the eyes of the law – a legally separate entity from its owners.

 

Some owners, however, have trouble keeping personal expenses out of the corporate checking account. These personal expenses are non-deductible, and in many cases are classified as loans from the corporation to the owners, or as repayments of prior loans made to the corporation by the owners. A recent court case highlights the danger of this practice.

 

A couple took nearly $740,000 out of corporations they owned, and classified them as discussed above. The IRS determined, and the US Tax Court agreed, that they were, in fact, dividends to the owners, and were fully taxable to the owners on their individual tax returns.

 

How do you help prevent this type of problem from occurring in your business? Below is a list of the factors the tax court considered in its decision – use these as a guide.

 

  • Document the intention to make a loan, and the intention to pay it back
  • Treat the loan like a loan- record the loan advances, calculate interest at a reasonable rate, have a repayment schedule.
  • Create a promissory note for all loans
  • Note that the loan advances and repayments are just that
  • Be sure the amount of money borrowed and loaned is not excessive given the financial position of the owners and the business.