Happy New Year! I hope your holidays were enjoyable. It’s hard to believe that another tax season is upon us.
I would like to thank you for allowing me to prepare your taxes in years past, and look forward to serving you this year. Like last year, the Tax Code, albeit complex, continues to provide me with opportunities to save you some money on tax, thus keeping your effective tax rate as low as possible while using my expertise to minimize any audit risk. I will outline some general tax topics of which you should be aware for this tax season, but once I review your specific 2014 tax scenario, I might have some other suggestions or strategies to reduce the impact of our higher tax environment. It is always my goal and heartfelt belief that every dollar I can save you in tax is a dollar better in your pocket than the government’s.
In a nutshell, the big issues that I think will affect most taxpayers are the new Obamacare reporting and taxing requirements, which for the first time in tax history, require you and I to discuss your healthcare and insurance coverage. There are also new regulations on businesses regarding asset reporting and depreciating which will cause a whole host of headaches for my small business clients. Lastly, the issue of what I call the phase daze! Many taxes phase in based on income levels and many deductions phase out based on numerous triggers including income levels. These act as hidden tax increases that the Government loves to play with as it allows them to technically claim that the rates did not go up, yet your individual tax hit certainly will if you fall into these traps. As good as they are at setting these traps, I am better at implementing techniques to avoid them!
In order to make this year’s process more convenient, while trying to hold the line on fees, my tax team and I will be implementing a number of new procedures that will hopefully make your experience better. As with any reputable professional tax preparation firm, tax file turnaround can be an issue. We realize that sometimes a return needs to be processed in an expedited manner. Like all tax preparation firms, we operate in a first in first out manner and endeavor to keep that turnaround as quick as we can. However, this year we are providing an alternative for those who need a fast turnaround or who may have procrastinated in getting documents to us by implementing a slight upcharge for expedited service beginning at $300. This will allow us to focus resources, while keeping our fees for regular turnaround reasonable.
As I noted above, the government has made some significant changes to the Tax Code for this year that may negatively impact your taxes, as well as how we report your income and expenses. Like last year, the tax rates remain high (in my opinion). I have outlined three major points below that you should be aware of, the Obamacare (Shared Responsibility Payment), the Phase Daze and lastly, the changes to what are known as repair Regulations for small businesses.
I. SHARED RESPONSIBILITY PAYMENT UNDER THE AFFORDABLE CARE ACT
Beginning in 2014, some of the most far-reaching provisions of the health care reform legislation became effective:
- the requirement to carry “minimum essential health coverage” for yourself and your dependents (known as the “individual mandate”);
- the ability to obtain coverage through an insurance exchange; and
- for qualified individuals, a special tax credit to help offset the cost of insurance.
If you fail to comply with the individual mandate to carry minimum essential health coverage, you are required to pay a penalty, called a “shared responsibility payment,” for each month of noncompliance. The rules stipulate that a person has minimum essential coverage for a month if the person is enrolled under a plan providing such coverage for at least one day during any calendar month.
Some individuals are exempt from the individual mandate, including, but not limited to:
- individuals covered by Medicaid and Medicare;
- incarcerated individuals;
- individuals not lawfully present in the United States;
- health care sharing ministry members;
- members of an Indian tribe;
- members of a religion conscientiously opposed to accepting benefits;
- individuals whose minimum cost for the annual premiums is more than eight percent of their household income;
- individuals who are without coverage for fewer than 90 days (although only one period of 90 days is allowed in a year); and
- individuals with employer-provided health insurance that satisfies minimum essential coverage and affordability requirements.
The shared responsibility payment amount is either a percentage of the individual’s income or a flat dollar amount, whichever is greater. The amount owed is 1/12th of the annual payment for each month that a person or the person’s dependents are not covered and are not exempt. For 2014, the payment amount is the greater of:
- One percent of the person’s household income that is above the tax return threshold for their filing status; or
- A flat dollar amount, which is $95 per adult and $47.50 per child, limited to a maximum of $285.
If you qualified for the tax credit that helps to offset the cost of coverage, you may have taken an advance payment of the credit. If so, you must reconcile the amount you received up front with the actual credit computed when your 2014 tax return is prepared.
II. INFLATION-ADJUSTED TAXES AND PHASEOUT AMOUNTS
Many of the taxes and exemption phase-outs in the Code are adjusted for inflation annually as well as a taxpayer’s income level, generally by the use of threshold amounts. In a nutshell, many common deductions and credits disappear for those taxpayers in higher income brackets. I call these phase-outs “stealth taxes” as you may not be aware of their impact on your bottom line. Some of these phase-outs impact your taxes on the following fronts:
A. Income Tax
The current tax structure includes income tax rates of 10, 15, 25, 28, 33, 35, and 39.6 percent. For 2014, the threshold amounts for these rates are:
- Married taxpayers filing jointly and surviving spouses: the maximum taxable income for the 10% tax bracket is $18,150; for the 15% bracket, $$73,800; for the 25% bracket, $148,850; for the 28% bracket, $226,850; for the 33% bracket, $405,100; and for the 35% bracket, $457,600. Amounts over $457,600 are taxed at 39.6%.
- Married taxpayers filing separately: the maximum taxable income for the 10% bracket is $9,075; for the 15% bracket, $36,900; for the 25% bracket, $74,425; for the 28% bracket, $113,425; for the 33% bracket, $202,550; and for the 35% bracket, $228,800. Amounts over $228,800 are taxed at 39.6%.
- Heads of households: the maximum taxable income for the 10% bracket is $12,950; for the 15% bracket, $49,400; for the 25% bracket, $127,550; for the 28% bracket, $206,600; and for the 33% bracket, $405,100; and for the 35% bracket, $432,200. Amounts exceeding $432,200 are taxed at 39.6%.
- Single filers (other than surviving spouses and heads of households): the maximum taxable income for the 10% bracket is $9,075; for the 15% bracket, $36,900; for the 25% bracket, $89,350; for the 28% bracket, $186,350; for the 33% bracket, $405,100; for the 35% bracket, $406,750. Amounts over $406,750 are taxed at 39.6%.
B. Additional HI (Medicare) Tax
Higher income individuals are subject to an additional 0.9 percent HI (Medicare) tax on wages received in connection with employment in excess of $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately).
C. Itemized Deduction Phase-out (Pease Limitation)
The Pease limitation on itemized deductions (named for the member of Congress who originally sponsored the legislation) reduces itemized deductions for higher-income taxpayers. For 2014, itemized deductions are reduced when AGI exceeds the following threshold amounts:
- $305,050 for married taxpayers filing jointly and surviving spouses;
- $279,650 for heads of households;
- $254,200 for single filers (other than surviving spouses and heads of households); and
- $152,525 for married taxpayers filing separately.
D. Personal Exemptions
The personal exemption phase-out requires higher-income taxpayers to reduce the amount of their personal exemptions when their AGI exceeds certain threshold levels. The same threshold limits used in the Pease limitation above apply to the personal exemption phase-out.
If the personal exemption phase-out kicks in, the total amount of exemptions that may be claimed is reduced by two percent for each $2,500 ($1,250 for married couples filing separately) or portion thereof, by which adjusted gross income (AGI) exceeds the applicable threshold.
E. Kiddie Tax
The net unearned income of certain children under the age of 24 can be taxed at the parent’s marginal tax rate. This tax at the parent’s rate is commonly referred to as the “kiddie tax.” If the child’s unearned income is less than an inflation-adjusted ceiling amount, the parent may be able to include the income on the parent’s return, rather than filing a return for the child.
For tax years beginning in 2014, the inflation-adjusted amount used to reduce the net unearned income reported on a child’s return that is subject to the kiddie tax is $1,000. The child’s income can be reported on the parent’s return if the child’s gross income is more than $1,000 and less than $10,000.
F. TAXES ON INVESTMENTS
Generally, taxable investment accounts are accounts other than retirement accounts, insurance contracts and annuities. When managing investments held in taxable accounts, the measure of success is the net return after taxes, rather than the gross return. The following taxes must be taken into account in order to achieve that objective:
G. Capital Gains Tax
Capital gains are taxed at a rate of zero percent for taxpayers in the 10 and 15 percent brackets; the 15 percent rate for taxpayers is applicable to those in the 25, 28, 33, and 35 percent brackets; and higher-income taxpayers that are subject to the 39.6 percent income tax rate pay 20 percent.
H. Tax on Dividend Income
Qualified dividends received from domestic corporations and qualified foreign corporations are taxed at the same rates that apply to capital gains. Certain dividends do not qualify for the reduced rates, including dividends paid by credit unions, mutual insurance companies, and farmers’ cooperatives.
I. Net Investment Income Tax (NIIT)
The net investment income tax (NIIT) is a Medicare surtax of 3.8 percent imposed on the lesser of net investment income (NII) or modified adjusted gross income (MAGI) above a specified threshold. Distributions from IRAs, pensions, 401(k) plans, tax-sheltered annuities, and eligible Code Sec. 457 plans are excluded from NII and from the NIIT.
NII includes the following investment income reduced by certain investment-related expenses, such as investment interest expense, investment brokerage fees, royalty-related expenses, and state and local taxes allocable to items included in net investment income:
- Gross income from interest, dividends, annuities, royalties, and rents, provided this income is not derived in the ordinary course of an active trade or business;
- Gross income from a trade or business that is a passive activity;
- Gross income from a trade or business of trading in financial instruments or commodities; and
- Gain from the disposition of property, other than property held in an active trade or business.
Individuals are subject to the 3.8 percent NIIT if MAGI exceeds the following thresholds (not subject to inflation adjustment):
- $250,000 for married taxpayers filing jointly or a qualifying widower with a dependent child;
- $125,000 for married taxpayers filing separately; and
- $200,000 for single and head of household taxpayers.
NIIT is not imposed on income derived from a trade or business, nor from the sale of property used in a trade or business. Therefore, it is important to differentiate income derived from an active business from passive investment income in order to shield the business income from the NIIT.
J. ALTERNATIVE MINIMUM TAX
The Alternative Minimum Tax “AMT” can also cause a nasty surprise in the higher income brackets and if you are subject to AMT, it can have a negative effect on standard tax reduction techniques. For example, if income and deductions are manipulated to reduce regular tax liability, AMT for 2014 may increase because of differences in the income and deductions allowed for AMT purposes.
The alternative minimum tax (AMT) exemption amounts are annually adjusted for inflation. For 2014, the AMT exemption amounts are:
- $82,100 for married taxpayers filing jointly and surviving spouses;
- $52,800 for unmarried taxpayers and heads of household, other than surviving spouses; and
- $41,050 for married taxpayers filing separately.
Exemptions for the AMT are phased out as taxpayers reach high levels of alternative minimum taxable income (AMTI). Generally, the exemption amounts are phased out by an amount equal to 25 percent of the amount by which an individual’s AMTI exceeds a threshold level. For 2014, the threshold levels for calculating the exemption phase-out are:
- $156,500 for married taxpayers filing jointly and surviving spouses (complete phase-out at $484,900);
- $117,300 for unmarried taxpayers and heads of household, other than surviving spouses (complete phase-out at $328,500); and
- $78,250 for married taxpayers filing separately (complete phase-out at $242,450).
The AMT rates are 26 percent, and 28 percent on the excess of alternative minimum taxable income (AMTI) over the applicable exemption amount. For tax years beginning in 2014, the taxable excess income above which the 28 percent tax rate applies is $182,500 for married taxpayers filing jointly and unmarried individuals other than surviving spouses; and $91,250 for married taxpayers filing separately.
III. Repair Regulations for Small Business
Final “repair” regulations are one of the largest guidance projects undertaken by the IRS in recent years as it relates to small business. The IRS issued temporary and proposed regulations in 2011. In 2013, the IRS finalized the complex and lengthy rules. The final rules, which are effective January 1, 2014, include a valuable provision for many taxpayers, especially small businesses.
The goal of the final repair regulations is to bring some certainty to the treatment of costs to acquire, produce or improve tangible property. Overall, both the proposed and final regulations generally require a taxpayer to capitalize amounts paid to acquire or produce a unit of real or personal property, including the related transaction costs. However, taxpayers can take advantage of a de minimis safe harbor. The safe harbor in the final regulations is much more expansive and generous than in the proposed regulations.
Originally, the IRS proposed to limit the safe harbor to taxpayers that had an applicable financial statement, had written accounting procedures for expensing amounts paid for such property under specified dollar amounts, and treated these amounts as expenses on its applicable financial statement. A taxpayer’s de minimis deduction for the tax year would be limited to a ceiling: the greater of (1) 0.1 percent of the taxpayer’s gross receipts for the tax year as determined for federal income tax purposes, or (2) two percent of the taxpayer’s total depreciation and amortization expense for the tax year as determined on the taxpayer’s applicable financial statement.
The proposed safe harbor was embraced by many taxpayers as a good start but more clarification was needed. Taxpayers raised concerns about the administrative burden of the proposed ceiling, noting they would be required to keep detailed accounts of amounts that they generally do not track because the amounts are expensed under their financial accounting capitalization policies. The administrative burden would appear to outweigh any potential tax benefit, taxpayers cautioned.
The IRS responded by eliminating the ceiling in the de minimis. The ceiling has been replaced with a new safe harbor, determined at the invoice or item level and based on the policies that the taxpayer utilizes for its financial accounting books and records. A taxpayer with an applicable financial statement may rely on the de minimis safe harbor only if the amount paid for property does not exceed $5,000 per invoice, or per item as substantiated by the invoice.
Additionally, the final regulations provide that the de minimis safe harbor applies to a financial accounting procedure that expenses amounts paid for property with an economic useful life of 12 months or less, as long as the amount per invoice (or item) does not exceed $5,000. These amounts are deductible under the de minims rule whether the financial accounting procedure applies in isolation or in combination with a financial accounting procedure for expensing amounts paid for property that does not exceed a specified dollar amount.
Moreover, the final regulations include a de minimis rule for taxpayers without an applicable financial statement. Under this approach, there is a reduced monetary threshold. A taxpayer without an applicable financial statement may rely on the de minimis safe harbor only if the amount paid for property does not exceed $500 per invoice, or per item as substantiated by the invoice.
The final regulations authorize the IRS to increase the $5,000/$500 de minimis amounts in future years. Our office will keep you posted of developments.
IV. IN THE END…….
As you can see the breadth of the current tax code can be dizzying. My team and I are ready to take maximum advantage of the code to help reduce your tax hit and minimize audit risk. I look forward to working with you and getting every penny you are entitled to. Thanks again for allowing us to be of service!
Michael T. McCormick