Tag Archives: taxes

Tax Penalty/Bonus? – Single, Married, Domestic Partnerships

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After nearly thirty years of marriage, I would be the last person to suggest that
tax consequences are a reason for making a lifelong personal commitment. On
the other hand, I am often the first to point out that marriage is not always a
tax neutral activity. Some people work on the expectation that a “married
filing jointly” (or MFJ) tax filing will always result in a lower combined tax
liability and a marriage tax bonus (meaning taxes are reduced solely due to
filing as MFJ). They are surprised when this joint filing actually creates a
marriage tax penalty (meaning filing MFJ results in higher taxes).

So when should we expect a penalty or bonus? The literature describes that ‘in
general’ we see a tax bonus when two partners have disparate incomes and a
tax penalty when they have similar or equal income. Based on the literature I
expected that income splitting (as occurs in a domestic partnership tax filing)
could provide an additional tax bonus over MFJ since disparate incomes can
be split evenly between partners.

While exploring the new 2013 tax rules we examined some tax scenarios and
want to share some highlights with you. We found that starting at a combined
AGI (Adjusted Gross Income–the number at the very bottom of the 1040
form) of $230K filing as MFJ resulted in a tax bonus of about $2K IF the two
people had disparate incomes ($200K and $30K respectively) but a penalty of
$2K for those with similar incomes ($115K each). Therefore at this level of
AGI couples with disparate incomes do slightly better under MFJ and those
with similar AGI do slightly better filing as individuals.

With a joint AGI of $330K the single disparate earners ($300K and $30K)
receive a marriage tax bonus of about $3K. If the same joint income was
earned evenly ($165K each) they would pay $4K more filing as MFJ than as
two individuals (a $4K tax marriage penalty). Looking at these scenarios, it
became clear that those with similar incomes would annually save thousands
of dollars if they filed as individuals rather than MFJ (Note: this is not the
same as married filing separately but rather unmarried individuals). As a
corollary, those in a domestic partnership may want to verify that they will not
have a large tax increase if they marry and file as MFJ.

Finally we looked at a couple with a $530K AGI who will pay $143K in taxes if
they file as two individuals with disparate incomes ($500K and $30K) and
taxes will be about the same if they file under MFJ (there is about a $1K tax
bonus). We do see a large tax penalty if this income was earned evenly by two
individual filers ($265K each) and they file MFJ. As two individuals the tax
burden would drop by at least $15K.

Marriage does provide non-income tax related advantages for spouses and
the family which are not discussed here.

Once you consider tax consequences of marriage, domestic partnership or
single tax filings any decision you make will work as long as you make plans to
cover the marriage tax penalty or find ways to spend the marriage bonus.
The above analysis assumed that ‘itemized deductions’ were kept constant and
that there was no AMT. These were modeled tax estimates – please consult
your tax preparers for the specific tax impact in your situation.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Taxes – Unintended Consequence of Trust on Home Sale

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No Capital Gain Exclusion for Residence that is Held in Family Trust

IRS recent ruling shows unintended consequence of trusts used to hold personal assets. This ruling reminds us that tax rules change after a trust can’t be changed, making trusts sometimes inflexible in dealing with changing tax opportunities.

In this case the sale of a home, in which an individual resided for many years but to which title was legally held by a family trust, did not qualify for the Tax Code’s new capital gains exclusion on the sale of the house. The exclusion would for most home owners provide a $250K per person tax free gain.  The IRS concluded that the individual’s inability to control the assets of the trust prevented her from being deemed an owner of the trust for tax purposes.  The intention was that her largest asset held in a revocable trust would give her ultimate tax advantage while protecting her on the downside – the reality is that if her trust converts to a irrevocable trust she is no longer able to sell her property and obtain the $250K tax free gain.

Family trusts are a common estate planning tool and often place assets, such as a home, into a trust. The income beneficiary has rights to any income from the trust and may even have use of the assets but has no control to sell, mortgage or dispose of the assets of the trust. Since only the trust’s designated trustees have the power to make decisions related to the encumbrance or disposal of the trust’s assets then the IRS deems that the beneficiary has preferential estate tax treatment only if they have the ability to continue living in the home.

Planning for the smooth transition of your assets to your family upon death can be complicated and can have serious tax ramifications. ALWAYS review all tax documents with financial advisor, estate planner and tax advisor.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

IRS: Banking transactions reported early 2012

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Banking Expenses are Going Up
Expect our fees to follow

The Internal Revenue Service just released this FAQ – that they are providing special transitional relief to banks and other payment settlement entities required to begin reporting payment card and third-party network transactions to the IRS on new Form 1099-K.  These are the fees that banks are trying to find a way to pass on to us, the consumer.

By law, reporting is scheduled to begin in early 2012 for payment card and third-party network transactions that occurred in 2011.

See details at:
http://www.irs.gov/newsroom/article/0,,id=249029,00.html

What is a third-party settlement organization?
A third-party settlement organization is a central organization that has the contractual obligation to make payments to participating payees (generally, a merchant) in a third party payment network. Characteristics of a third party payment network include: (i) the existence of a central organization with whom providers of goods and services have established accounts, (ii) an agreement between the central organization and providers to settle transactions between the providers of goods and services and purchasers, (iii) the establishment of standards and mechanisms for settling such transactions and (iv) the guarantee of payment in settlement of such transactions. The most common example of a third-party settlement organization is an online auction-payment facilitator, which operates merely as an intermediary between buyer and seller by transferring funds between accounts in settlement of an auction/purchase. Third-party settlement organizations charge sellers a fee for facilitating the transaction. Under the reporting requirements, these entities must report the gross reportable transactions of the businesses to which they make payments provided the payee satisfies certain transaction volume and dollar thresholds.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Government Policy To Watch

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Financial Policy in the news
Government policy that will impact our bottom line

1. Senate replaces Obama tax increases with millionaires’ tax

When President Barack Obama announced his jobs package in early September, he proposed paying for the measure with a series of tax increases on individuals making more than $200,000 and families making more than $250,000. Among them was a 28% cap on the tax exemption for municipal bond purchases and a hike in the tax on “carried interest” for private fund managers from the capital gains rate to the individual rate. In their version of the jobs plan, Senate Democrats replaced the Obama tax increases with a 5.6% surcharge on millionaires. The tax would apply to adjusted gross income less investment interest deduction above $1 million. Senate Democrats believe that the $1 million threshold more clearly delineates the difference between the middle class and the wealthy.

2. Obama’s jobs plan sliced, diced, stalled in Congress

In rallies around the country earlier this fall, Mr. Obama touted his jobs package and urged Congress to “pass this bill now.” By October, he was hoping that Congress would approve at least parts of it. It’s been slow going. The Senate blocked the entire $447 billion measure from getting to the floor. It was then diced up into smaller parts, and some blocked later on. The first portion of the package to get any traction was a provision to repeal a tax on government contractors that is set to go into effect in 2013. The bill’s prospects in the Senate are unclear.

3. Bills to promote crowd funding, raise SEC registration thresholds pass House Financial Services Committee

A bill that is similar to another piece of Mr. Obama’s jobs package was approved by the House Financial Services Committee on Oct. 26, would allow so-called crowd funding to finance startup companies by allowing the firms to pool small investments up to $5 million without having to register with the Securities and Exchange Commission. State regulators object, arguing that the bill would foster fraud.

4. What is the Buffett Rule? Capitol Hill steps into the definition vacuum

As he ramped up his re-election effort this fall, Mr. Obama proposed a so-called Buffett Rule. Named after Warren Buffett, the idea is that middle-class taxpayers should never fork over a higher percentage of their earnings to the federal government than the wealthy. The notion is based on Mr. Buffett’s suggestion that it is wrong for him to pay taxes at a lower rate than his secretary. A new bill, imposes an additional 5% tax on income from $350,000 to $500,000, 10% on $500,000 to $1 million, 15% from $1 million to $10 million and 20% on income exceeding $10 million. Another group has put forth a far different concept – taxpayers would be allowed to donate money to the Treasury Department to help pay down the national debt.  This last ‘concept’ has always been available BUT has yet to generate any income.

5. Republicans try to set rates on capital gains and dividends at 15% permanently and remove health care tax

House and Senate Republicans are attempting to bring some certainty to tax policy through a measure that would set capital gains and dividends rate permanently at 15%. If Congress does not extend the Bush tax cuts, the capital gains rate will rise to 20% and dividends will be taxed at individual rates beginning in 2013. In addition, the GOP is trying to get rid of a 3.8% Medicare tax that will be assessed on investment income starting in 2013 to help pay for the health care reform law.  Not sure how they plan to pay for it in a balanced budget BUT it may be a way to stop Obamacare by stopping its funding.

6. Legislation could allow retirement account borrowing to pay mortgages

Retirement savings advocates are wary of a bill that would allow penalty-free withdrawals from tax-exempt pension and retirement plans in order to pay mortgages.  It already allows it in 401K plans.  I would prefer that they borrow than withdraw BUT not for mortgage payments without a financial plan that helps them get ‘real’ to their current financial situation.

7. DOL on fiduciary-duty rule

The Labor Department is making clear to the financial industry that it is not abandoning a regulation that would significantly expand the definition of “fiduciary” for investment advisers to retirement plans. The agency withdrew a proposed rule in September which would increase regulatory and liability costs, and would drive brokers out of the individual retirement account market because it would subject them to fiduciary duty for the first time. But why would we want brokers who don’t follow fiduciary duty to be in the individual retirement market?

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Taxes prior to Debt Super Committee Vote

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2012-13 Tax Planning
– Prior to Debt Super Committee meeting deadline (Nov 23rd)

There are at least 60 income tax provisions scheduled to expire at the end of 2011 but even if they do the most significant income tax changes are expected in 2013.

The Bush tax cuts are set to expire and income tax rates rise in 2013. At that time, itemized deductions would once again be partially phased out, the estate tax exemption will drop precipitously and the estate tax rate will jump unless they are re-enacted.  At the same time we’ll begin the new healthcare surtax in 2013 that will result in 3.8% tax increase on
certain types of investment income and a tax of almost 1% on wages above a specified threshold.
Between now and 2013, we expect much talk about changes but the Congressional bipartisan ‘supercommittee’ is considering controversial revenue-raising measures, such as limiting itemized deductions for high income tax payers and other altered tax treatments. The vote & recommendations on November 23rd will play a large part in our confidence that our economy will begin to grow soon before the tax increases in 2013.

Our long term success still remain with business growth and ability to create and support well paying jobs.

What does this mean for investors? That we plan for what we know, not what might happen.  But we keep our eye on what changes are approved so that we can adjust and still reach your personal and professional goals.

This year and next year (are consistent with 2010) present us with tactical and strategic decisions that may require action before those rules expire.

Here are two lapsing provisions:
AMT Patch was extended from 2010 to 2011. If Congress
does not extend it, the AMT exemption for 2012 would
return to earlier, lower levels and will result in more tax owed.

The portion of the Federal Insurance Contributions Act (FICA) tax that goes to Social Security was reduced temporarily in
2011 from 6.2% to 4.2%. With no extension, the higher rate
returns in 2012.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Itemized or standard Deductions? – that is the question.

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The ultimate test for when it is worthwhile to forget the no-questions-asked standard deduction and do the record keeping required to itemize is when the total itemized deductions surpass the standard deduction – an amount that is based on variables, such as filing status and age, and is adjusted upward each year to reflect inflation. So read on … do the numbers and decide! 2009 Tax time is here.

The Standard Deduction

The standard deduction for 2009 is $11,400 for joint filers and surviving spouse, $5,700 for singles or filing separately and $8,350 for heads of households. If a couple files separately they must BOTH file deductions the same way.

At age 65 and over you can add another $1,100 for married person and $1,400 for those filing single or head of household. You can also add another $1,100 for each blind person.

The standard deduction decreases for those who can be claimed as dependents on the returns of other people – can be as little as $950.

There is an inconsequential break that is in the books for 2008-09 that will benefit two types of clients – those who purchased homes late in the year and have NOT paid enough mortgage interest and taxes to make itemizing worthwhile OR those who have already paid their home mortgage. These home owners will not need to itemize but can claim extra deductions of up to another $1,000 for joint filers or $500 for other returns. The actual amount will be the same as the amount of the real estate taxes on Schedule A.

Another 2008-09 authorized addition to standard deduction (in place of Schedule A itemizing deductions) for those whose properties were damaged or destroyed in places declared federal disasters. The standard deductions is increased by the uninsured losses attributable to natural disasters like hurricanes, fires, floods, earthquakes and landslides without the requirement that it exceed 10% of AGI or exceed $500.

There is also an add-on for the standard deduction for those who bought a new motor vehicles between Feb 17 and Dec 31. The total of state and local sales and excise taxes will be added to the standard deduction up to $49,500 car purchase. The motor vehicle must be a new car, sport-utility, light trucks, motorcycles (at least 8,500 lbs) and mobile homes BUT NOT used cars or leases.

Many standard deduction extras are not available for those with AGI higher than $13K for individuals and $260K for joint filers.

On the other hand, itemizers will be able to have full deductions in charitable contributions, state and income tax or sales tax (not both), real estate taxes and interest on most home mortgages but only a limited write-off for medical expenses, casualty & theft losses and miscellaneous expenses.

AMT and Itemized/Standard Deductions

Whether using itemized or standard deductions all filers may have to deal with additional tax from the alternative minimum tax (AMT). AMT disallows standard deduction amounts and restricts several itemized deductions. It allows medical expenses only for the portion above 10% of AGI (not 7.5%). AMT also disallows deductions for interest on home equity loans (not used to purchase or improve home), state and local property and sales taxes, and most miscellaneous deductions.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Tax: First time home buyer credit

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First Time Home Buyer Tax Credit and your 2008 tax withholdings:  Are you eligible?

This tax credit is limited to those with an adjusted gross income (AGI) of less than $95K and $170K (single and joint filer) and who buy a personal residence between April 9, 2008 and July 1 2009. The credit is disallowed if the property is no longer your principal residence before the close of the tax year. It is also disallowed if you are classified as a nonresident alien, or your financing is from tax-exempt mortgage revenue bonds. You must be a first time home buyer which is defined as having no ownership interest in a principal residence during the three prior years. You must be a US citizen or US resident alien.

How much and how will you receive the credit?
The maximum amount for any Home Buyer Tax Credit is $7,500 and it is a refundable credit (which means that you will get the credit even if you don’t owe taxes). If you owe $5,000 and your credit is $6,000 you will receive a check for $1,000. It phases out at $75K and $150K (single and joint filers). You will receive the credit when you file but if you qualify you may adjust your withholdings or estimate taxes to accommodate this credit.

What is the catch?
The biggest catch for Bay Area home owners is that most do not qualify. If you do qualify for many home purchases you often need to earn enough to cover a fairly large mortgage which will, in many cases, place you above the limits to claim some or all of this credit. In addition, this is not “free money.” It is a 15-year no interest loan that must be paid back at $500 per year.

What should you do?
First determine if you are likely to qualify this year or early next year. If you do qualify, then consult with your tax planner or accountant and adjust your withholdings or estimated taxes either this quarter or early next year.
For the original documents, check the links on our resource page: www.aikapa.com/links.htm

** Please note, this is a Financial Bites column provided for general use by our clients — always check with your tax planner or accountant **

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com