2012 Year In Review

BUCK CPA 2012 YEAR-END TAX NEWS

We have now reached the point where “taxmaggedon” is just around the corner. Many of you have been trying to keep abreast of what is on the horizon and how it might affect you. In this report we will attempt 2012-Year-in-reviewto inform you 1) of what things will “definitely” change in 2013, and 2) of what changes “might” be coming at us for 2013 and beyond. We will also try to advise you regarding some actions you might wish to consider taking before the end of 2012 that could have a beneficial effect on this year’s tax return.

Converting to a Roth IRA – if you are considering making a conversion of your traditional IRA to a Roth IRA, you should consider getting it done during 2012. In 2013 there will be an additional 3.8% Medicare surtax tax on unearned income (unearned income includes interest, dividends, capital gains, and, of course, Roth IRA conversions) for so-called “high earners” defined as single individuals earning more than $200,000 and married couples earning more than $250,000. If you were to convert $100,000 to a Roth IRA, you could save almost $4000 in additional taxes by making the conversion before year end. Please remember that funds withdrawn from a Roth IRA are tax free, while those taken from a traditional IRA are added to all other income and will be taxed at your top marginal rate.

To the extent possible, you should consider accelerating income into 2012 and putting off claiming expenses until 2013. As we mentioned in last year’s tax letter, this is completely contrary to the approach taken in prior years.

If you have been earning income from e-commerce activities (including payments from PayPal and other payers), expect to receive form 1099-K reporting gross receipts from your activities. As with all 1099s of any sort, this income is reported to the IRS. If you do not report the income, you can be guaranteed to hear from the IRS in the form of a correspondence audit. It is worth our discussing this briefly because I know of people who have been earning money through these sources (e-Bay, Craig’s list, etc.) but have not been reporting the income on their tax returns. Don’t get caught neglecting to report this sort of income because it could cost you big time, especially if it causes the IRS to audit other items on your return. See our comments later in this report about how you can minimize the tax affects if you have this kind of income.

If you are holding investments that have increased significantly in value, you might want to consider selling them before the end of 2012, given that long-term capital gains rates are going up in 2013, especially for high earners.

For the past few years the government has been trying to help us keep our taxes a bit lower – first by giving a maximum credit of $400 per person with earned income. This lasted for a couple of years and was then replaced by the 2% cut on payroll taxes (Social Security and Medicare). At this time it does not appear that this tax cut will continue to be in place after 2012. This “tax increase” – really nothing more than a reversion to the prior rates – will hit everyone with “earned” income (from w-2 and self-employment). This would seem to fly in the face of the administration’s continuing insistence that “low and middle-income” earners will NOT see any increase in taxes.  Instead of having 5.65% taken directly from your paycheck, the rate will once again go to 7.65%. For those who do not earn enough to have any income tax liability, this calculates to a tax increase of 35%.

Aside from the 3.8% increase in tax on unearned income discussed above (by the way, this tax will also hit any gain you might have on the sale of your personal residence), we are certain that 2013 will see an increase of 0.9% on earned income for the “high earners”. These are the changes that are certain for 2013 and beyond. But what about the possible (probable?) tax increases that could come out of the lame-duck session of Congress and the actions of the next Congress.

Most of us are aware that the Bush-era tax cuts are now scheduled to go away at the end of 2012. There has been conjecture that the cuts will be allowed to remain in place for one more year (2013), but not for the high earners. If they are extended for low and middle class earners, you might not see much change from 2011 and 2012 to 2013. However, there is no guarantee that this extension will be adopted and even if it is adopted, it is unlikely that it will be extended beyond 2013.

So what will it mean if and when these tax cuts are allowed to expire? Nothing that would be beneficial to any of us, that is a certainty. Here is a “short” list of how taxes will increase:

  1. The 10% tax rate that applies to the first level of taxable income will be eliminated and this rate will rise to 15% (that equates to a 50% increase on the lowest income earners).
  2. Dividends and capital gains will be taxed at higher (in some cases MUCH higher) rates.
  3. The marriage penalty comes back in meaning that two single taxpayers will pay less tax than a married couple earning similar incomes.
  4. The child tax credit reduces for $1000 to $500 per child.
  5. The top two tax rates go from 33% and 35% to 36% and 39.6%, respectively. These rates do NOT include the 3.8% increase on unearned income or the 0.9% increase on earned income for high earners.
  6. The deduction for student loan interest goes away.
  7. Some of the credits for higher education expire.
  8. The child-care credit reduces.
  9. There is a major reduction in earned income credits and refunds.
  10. High earners will lose their ability to deduct a portion of their itemized deductions and personal exemptions.

Ernst & Young (one of the largest accounting firms in the world) has made some calculations of what actual tax rates could end up being in various circumstances.

  • The top rate on dividends goes up to 44.7% while the top rate on long-term capital gains goes to 24.7%.
  • The percentage increases would be as follows:
  1. 5.0% on wages
  2. 6.4% on flow-through income (from partnerships, S-corporations, estates, & trusts)
  3. 16.5% on interest
  4. 157.1% on dividends (this increase is not a misprint)
  5. 39.3% on capital gains.

AND, we have not even begun to discuss the effects of tax and penalties connected to Obama Care, which is now certain to go into full effect over the next several years. We do not intend to attempt to give details on how Obama Care will affect our tax lives other than to observe that the effect will have a major impact on everyone’s pocketbook.

As to what you can do about saving tax dollars, unless you operate a small business, there is precious little you can do. We have discussed the tax benefits that are available to small business operators several times in the past. As the tax bill goes up and up you might want to give more consideration to starting your own business. For those of you engaged in e-commerce (as we discussed above) if you don’t learn how to apply your legitimate business expenses to reduce this income, you will pay MUCH higher taxes that you should.

One final comment with regard to small businesses – the IRS is increasing its audit rate for all businesses, including S-corporations, meaning there is more likelihood of being audited. You should make sure that you have documentation to support every line of your business returns. However, there might be a way to keep a much lower audit profile and that is by operating your business as a C-corporation. The IRS has shown much less interest in auditing these entities. C-corporations are not for every business, but you should at least consider looking into it.

In the very near future we will have a new educational series available for purchase which will help you structure your small business to take advantage of many of the tax-saving methods available. Congress regularly passes laws designed to help small businesses. Unfortunately, many of these benefits hide in the tax law and are not taken advantage of by businesses. Our new series will clue you in on what is possible. Some of our clients realize tax savings of thousands of dollars each and every year by using these completely legal methods. If you operate a small business, you owe it to yourself to know about and utilize these tax savers.

All in all, one thing is certain, the government is broke and will continue to seek out other ways of increasing tax collections, including additional tax increases, but also including a MUCH more active IRS when it comes to audits and heavy-handed collection methods. As many of you are aware, Buck CPA has two major specialties. One is helping people structure and operate small businesses and the other is standing up for those having IRS audit or collection problems. Don’t hesitate to contact us for assistance.

Concerning what to expect from the IRS and Congress, there seems to be little reason for optimism. Nevertheless, we wish you a Happy and Prosperous New Year!

 

Defending our fellow citizens against their government by making sure the IRS obeys the rules.