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Tax Update as of 12/14/2012

As the stalemate on taxes continues between President Obama and Speaker Boehner…

Look at two tax hikes that will apply in 2013, regardless of the outcome of the current negotiations. IRS has issued guidance on these Medicare surtaxes for upper-incomers…a 3.8% tax on unearned income and a 0.9% levy imposed on their earned income.


Start with the 3.8% Medicare surtax. It applies to unearned income of single filers with modified adjusted gross incomes above $200,000 and of couples over $250,000. Marrieds filing separately get a $125,000 threshold. Modified AGI is AGI plus any tax free foreign earned income. The surtax is levied on the smaller of the filer’s net investment income or the excess of modified AGI over the thresholds. Investment income includes interest, dividends, payments of substitute interest and dividends by brokers, capital gains, annuities, royalties and passive rental income. Tax free interest is exempted, along with payouts from retirement plans such as 401(k)s, IRAs, deferred-pay plans and pension plans.


Most gain on the sale of a primary residence is exempt from the surtax. Only profit in excess of the $250,000 exclusion for singles or $500,000 for couples can be hit by the surtax. But the levy can apply to all gain on a second home.


Income from a passive activity is subject to the surtax if the recipient doesn’t materially participate in the operations, even if the income is from a business.


Now turn to the 0.9% Medicare surtax on earned income…wages and income from self-employment. Singles will owe the levy once total earnings exceed $200,000. Couples…over $250,000. Marrieds filing separately…over $125,000. So for earnings

over the thresholds, the effective Medicare tax rate will be 3.8%…the usual 2.9% rate plus an extra 0.9%. The surtax applies only to the employee’s share of Medicare tax.


Employers don’t owe it. Employers will withhold the surtax once an employee’s wages

exceed $200,000. Employees will then calculate the actual tax due on their 1040s.

So marrieds who each make below the $200,000 threshold but expect their total wages

to top $250,000 in 2013 should consider having more income tax withheld on their pay


Year End Tips:


Our final tax reminders for 2012 so you can avoid making last-minute errors:


Check the balance in your flexible spending account. You must clean it out by Dec. 31 if your employer still has not implemented the 2½-month grace period that IRS now permits. Otherwise, any money remaining in your account is forfeited.

Remember that a $2,500 annual ceiling on health FSA payins takes effect for 2013.


People 70½ and over must take their payouts from IRAs and company plans by year-end. You start with your Dec. 31, 2011, IRA balances and divide each of them by the factor for your age, which you can find in a table in IRS Publication 590.You can use a higher factor if you are more than 10 years older than your spouse. The sum of these amounts can be taken from any IRA you pick. The process is similar for retirement plan payouts, but you must take the required amount from each plan.


If you turned 70½ this year, you can delay the distribution for 2012 to April 1, 2013. But this option doesn’t apply for payouts in subsequent tax years, and the withdrawal for 2012 must still be based on the total of your IRA balances as of Dec. 31, 2011. And be careful if you decide to defer the distribution to 2013. Doing so means that you will be taxed in 2013 on two payouts: The one for 2012 that you deferred and the required withdrawal for 2013. The doubling-up of payouts in one tax year could have the effect of pushing you into a higher tax bracket.


Note the various deadlines for retirement plans, IRAs and Coverdells. Generally, employer plans such as Keoghs must be established by Dec. 31 so payins to them can be deducted for 2012. Self-employeds who miss the Keogh setup deadline for 2012 can open up a SEP by the due date for filing the 1040 plus any extension.  Keoghs and S EPs have the same payin cap: 20% of net self-employment earnings… the net profit shown on your Schedule C less one-half of your SECA tax liability.


Regular IRAs must be established by April 15, 2013, for 2012 deductions. Payins are due by then as well. A filing extension will not buy you additional time. Nondeductible payins to IRAs and Roth IRAs are also due by April 15. Ditto for contributions made to Coverdell education savings accounts.


If you are making a gift by check, be sure the donee deposits it in 2012 if you want the money to count as a 2012 gift for gift tax purposes. Alternatively, deliver a certified check to the recipient this year. That will count as a 2012 gift, even if the donee does not deposit the check into his or her account until next year. Remember that if you don’t use up the full $13,000-per-donee exclusion this year, you lose the shortfall forever. You can’t give a donee extra next year to make up for it.


If you’re giving securities, endorse them over to the donee and deliver them by year-end if you want the gift to count for 2012. If you send them to the corporation late in the year to be retitled, the process might not be completed by Dec. 31.


Mail checks for deductible items before year-end to ensure a 2012 write-off. You’re able to claim the deduction this year even if the checks don’t clear until Jan.  And make sure you know the tax rules if you are charging deductible items.


For charges that you make with a retail store credit card, you are allowed to claim the deduction for the item only in the tax year in which you pay the bill. For transactions made with a bank credit card, you take the write-off in the tax year that you charged the goods, even if you pay the bill next year.


Business Taxes:

The standard mileage rate for business driving is ticking upward for 2013. The rate will increase to 56.5¢ per mile, up a penny from 2012. Businesses with fewer than five vehicles can use the allowance. If you use the standard rate, you must reduce the vehicle’s basis by the depreciation component…23¢ per mile.


The rate for medical travel and moving will rise to 24¢ a mile next year, up 1¢ from this year. But the rate for charitable driving will stay static at 14¢ a mile because the amount of that write-off is determined by Congress, not by the IRS.


You also can claim the cost of parking and tolls. Use of the standard rate won’t bar deducting personal property taxes on the vehicle. But you can’t add the cost of fuel or repairs. And you can’t use the rates if you depreciated or expensed the car.


A warning to accrual method firms that pay bonuses to their employees:

The tax write-off is delayed if the funds can revert back to the employer, IRS lawyers say. A firm pays its workers bonuses a couple of months after year-end, based on their performance in the prior year. Under the plan, if an employee leaves after the manager finalizes the awards but before payment is made, his or her share is forfeited to the company. Thus, the firm’s liability isn’t fixed until the money is paid.


Watch what you put on a credit application. IRS may use it against you, as a woman who ran a cash-intensive massage therapy business at home discovered. She failed to file tax returns and didn’t cooperate with the Service during the audit. IRS reconstructed her income, relying on the income she listed on a credit application she filed with a bank. The Tax Court sided with IRS (Trescott, TC Memo. 2012-321).


Preparers of earned income credit returns for 2012 have extra work to do.

The IRS is requiring more documentation of due diligence efforts. Preparers of returns taking the credit must submit Form 8867 to show how they determined that the filer’s claim for the credit was valid, or IRS can slap a $500 penalty on them. Now, preparers will have to detail the documentation that clients supplied on issues such as residency and disability of qualifying children, as well as income reported on Schedule C. Preparers also have to disclose whether they asked follow-up questions when a qualifying child wasn’t the client’s child or when a child lived over six months during the year with someone else who could also claim the credit for the child.


IRS is eyeing businesses that fail to report income shown on 1099-K forms. It compared 1099-Ks filed by credit card companies and third-party networks such as PayPal with income shown on returns by taxpayers who received the forms. It’s now mailing notices to firms it believes may have underreported gross receipts.


But the 1099-K matching program is imprecise. The form reports receipts for a calendar year, which doesn’t jibe for firms with fiscal years. And businesses don’t have to separately report amounts shown on 1099-Ks. So the form’s usefulness as a tool to spot underreporting is lessened. Nevertheless, IRS will still ask businesses to explain discrepancies and will follow up with firms that don’t respond to the notices.


The Service is getting serious about the governance practices of nonprofits. Based on the results of surveys that agents fill out after exempt-organization audits, IRS believes nonprofits with good governance policies, such as independent boards and written management policies, are more tax compliant. It will test this premise by examining 200 social welfare groups and a like number of charities next year.


The Revenue Service is tightening the rules for individual tax ID numbers. ITINs are issued to individuals who are not eligible to get Social Security numbers. Newly issued ITINs will expire after five years unless the recipient reapplies for validation, IRS says. And all applicants must supply original documentation of identifying information, such as birth certificates or passports, or copies certified by the issuing agency. Folks can mail the documents to IRS along with Form W-7,or submit them to a certifying acceptance agent. The Service has tightened the rules on these agents, too.


Filers with ITINs who claim the refundable child tax credit are on IRS’ radar.

It’s clamping down after being criticized for permitting too many bogus tax refunds.

Schedule 8812 will require more residency information for dependents with ITINs.

And the Service is reconfiguring its computer programs to screen questionable claims.

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