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Where the Great Tax Debate is Headed
by Dennis V. King, CPA, Managing Partner
We haven't heard the end of the debt limit or debt ceiling negotiations after this summer's Congressional turmoil to adopt a budget. While the turbulence didn't result in any immediate tax legislation, the debate gave serious momentum to the discussion for a whole bevy of fixes including tax increases, rate hikes, rate reductions and general tax reform.
It is unknown whether tax legislation will be recommended and passed by the end of 2011 in response to the immediate directive to trim the deficit. Congress also needs to act on the Bush-era tax cuts set to expire after December 31, 2012.
Congressional hearings on tax reform continue to be held on Capitol Hill. Initial proposals have been introduced recently by the White House Deficit Commission Report, the Republican Study Committee, and the so-called Gang of Six, a bipartisan group of Senators suggesting ways to cut trillions from the deficit over the next 10 years. Expect elevated discussions to ensue as Congress is forced to deal with tax reform in an era in which careful budgeting is essential to economic growth.
Administration's Proposals. At the center of President Obama's plan to trim the deficit is an extension of the Bush-era tax cuts for lower and middle income taxpayers after 2012, but not for some higher income taxpayers now in the top two rate brackets. Under the president's plan, taxes would increase for higher income individuals, defined as individuals with incomes above $200,000 and families with incomes above $250,000. The White House has also called for the elimination of certain oil and gas tax preferences, a permanent research tax credit and an extension of the 2011 payroll tax cut.
Gang of Six Tax Proposals. In early 2011, six members of the Senate, now known as the Gang of Six, began negotiations on a comprehensive deficit reduction plan. In July, the senators released a bipartisan blueprint to reduce the budget deficit by $3.7 trillion over 10 years through a combination of spending cuts and revenue raisers.
House Republican Study Committee. Comprised of 175 conservative members of the House, the Republican Study Committee passed a deficit reduction proposal in July that did not include any tax increases, but was ultimately rejected by the Senate. The committee has called for a "smarter" Tax Code that would lower rates while broadening the tax base, but offered no specifics on how that would be accomplished.
White House Deficit Commission. Formally known as the National Commission on Fiscal Responsibility and Reform, the 18-member group developed a six-part plan designed to reduce the federal deficit by almost $4 trillion by 2020. The plan aims to reduce, if not eliminate, $1.1 trillion in tax expenditures in the current Tax Code for individuals and businesses, such as the tax-free treatment of contributions to health care plans.
Other substantial tax expenditures include disallowing portions of the home mortgage interest deduction, curtailing accelerated depreciation, raising capital gains rates, and tightening the availability of the earned income credit.
At the same time, the plan would reduce tax rates, the amount depending on the amount of tax expenditures eliminated. Under one scenario, the Deficit Commission's plan would provide three ordinary income tax rates for individuals as low as 8, 14, and 23 percent. The plan would treat capital gains and dividends as ordinary income, and the alternative minimum tax (AMT) would be eliminated.
Other targeted reforms proposed by the Deficit Commission include limiting the charitable deduction for individuals to amounts over two percent of adjusted gross income; repealing the state and local tax deduction for individuals; repealing all miscellaneous itemized deductions for individuals; capping the income tax exclusion for employer-provided health insurance; and raising the federal gasoline tax by 15 cents per gallon.
The Deficit Commission plan would provide a single corporate tax rate of 26 percent, compared to the current maximum rate of 35 percent. Additional business-related reforms include eliminating the Code Sec. 199 domestic manufacturing deduction, the LIFO (last-in, first-out) method of accounting, and oil and gas production incentives.
Senate Finance Committee. The Democratic-controlled Senate Finance Committee has examined, among other issues, oil and gas tax preferences, the tax treatment of business and household debt, strategies to increase the voluntary compliance rate to 90 percent, and efforts to close the tax gap.
House Ways and Means Committee. The Republican-controlled House Ways and Means Committee has also held a series of hearings on tax reform in recent months examining, among other issues, the advantages and disadvantages of a value added tax, tax incentives to encourage foreign investment in the U.S., and the corporate tax rate.
As you can see, there's no shortage of attention when it comes to dealing with our nation's deficit and related debt ceiling discussions. At the end of the day, tax reform is imminent. The tax and accounting professionals at KKAJ are following developments as they occur and are available to discuss your personal tax situation. Contact us at (818) 848-5585.
Planning for Medicare's Surtax
by Charles R. "Bud" Alleman, CPA, Partner
The Patient Protection and Affordable Care Act was signed into law by President Obama in March 2010. While certain elements of the legislation have already taken effect, one piece that won't begin until January 1, 2013 is the Unearned Income Medicare Contribution, which was used to help finance the healthcare reform.
The contribution takes the form of a 3.8 percent surtax on certain types of unearned income of individuals, trusts and estates with income above specific thresholds. In addition to the surtax, the top income tax rate is set to increase in 2013 to 39.6 percent, yielding a top marginal rate of 43.4 percent. The top capital gain rate is set to increase to 20 percent that same year.
The constitutionality of the healthcare legislation has been adjudicated in several state courts, and will likely make its way to the U.S. Supreme Court to be decided once and for all. However, it is still important to plan for the event.
With that in mind, let's take a look at the rules regarding when the surtax applies (see call out box) and offer some planning strategies to eliminate or mitigate the additional tax liability, and explain the surtax's application with respect to home sales.
Home sales have the ability to trigger the surtax if the taxpayer's Modified Adjusted Gross Income (MAGI) exceeds the threshold amounts, and the sale of a principal residence results in a capital gain that is greater than $250,000 for single taxpayers and $500,000 for married couples. The surtax could also apply if a taxpayer sells a non-principal residence that results in a capital gain.
The following strategies may be utilized to manage the income threshold limits, as well as the amount of net investment income incurred by the taxpayer. Keep in mind that tax planning is only one element of a comprehensive plan, and strategies should only be considered if they fit into your overall, long-term plan.
Roth IRAs. Distributions from Roth IRAs are not taken into account when analyzing the income thresholds for the taxpayer, nor are they considered net investment income. If you are planning to convert a Traditional IRA to a Roth IRA, consider paying for the tax liability from a source other than the IRA. If the tax is paid from a taxable portfolio producing net investment income, that portion of the portfolio used will be shielded from the surtax.
Traditional IRAs. Making deductible contributions to an IRA will lower an individual's MAGI; non-deductible contributions will not. While the minimum distributions Traditional IRA owners are required to take upon reaching age 70 ½ are not considered net investment income, they will count toward the surtax's income thresholds.
Maximize Qualified Retirement Plan Contributions. Current contributions to qualified retirement plans reduce income, which could keep income below the MAGI thresholds.
Municipal Bonds. Income from municipal bonds is not considered net investment income, nor is it considered for purposes of the surtax's income thresholds. If you intend to rebalance your portfolio to increase its municipal bond exposure, it may trigger capital gains. However, it may be advantageous to pay those gains now since the rate is set to increase in 2013.
Wealth Transfer Planning. Although gifting ordinary income or net income producing property to individuals in lower income brackets may trigger gift tax to the donor, it will remove the asset from the donor's possession, thereby reducing the donor's income from such asset. Family limited partnerships can serve as vehicles to shelter a portion of an individual's net investment income. For parents gifting to younger generations, this planning strategy can also help reduce the size of the parents' gross estate for estate tax purposes.
Charitable Planning. Gifting income-producing property to a charity can remove the asset from the donor's possession, reducing the income associated with the asset. Further, it may result in an immediate charitable income tax deduction, further reducing the donor's income. Another option would to establish a Charitable Remainder Trust creating both an income and remainder interest. Structuring a level income stream during the trust term may keep the beneficiary's income below the surtax's threshold limits. Since this type of trust is a tax-exempt entity, the trust has the ability to sell the contributed assets free of tax and then reinvest the proceeds as it sees fit. Similarly, a Charitable Land Trust is a split interest trust consisting of both an income and remainder interest. Upon creating this type of trust, the donor receives a charitable income tax deduction equal to the present value of the income interest transferred to the charity, which can be used to offset net investment income.
Business Succession Planning. Installment sales may be used to limit the amount of net investment income in any one year, as well as manage the taxpayer's MAGI to avoid exceeding the income thresholds. Net investment income does not include gains on the sale of business property from an active trade or business. However, the proceeds will be taken into account for MAGI purposes. If there is an opportunity to sell an asset prior to 2013, the potential advantage of a lower capital gains tax rate and no surtax should be considered in evaluating the transaction.
Lower Annual Income Through Deferral. Defer income over time to reduce income each year below the MAGI threshold.
Qualified Stock Option Planning. Consider an early exercise of qualified stock options to start the long-term capital gain holding period. If exercised before the end of 2012, the stock could be sold at current capital gains rates before the surtax becomes effective in 2013.
Minimize Sources of Net Investment Income. Income associated with passive activities, limited partnerships, gains on sales of passive property, rental real estate, activities with no material participation, and undistributed taxable income from trusts should be minimized.
Discretionary Distributions from Trusts. Distribute more net investment income to the lower income trust beneficiaries if the Trustee has the ability to make non-pro rata allocations to avoid the surtax.
Who Is Affected?
The surtax will apply to individuals, trusts and estates if certain thresholds are met.
For individuals, the 3.8 percent surtax is imposed on the lesser of:
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Net investment income for the tax year; or
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The amount by which the modified adjusted gross income exceeds the threshold amount in that year. The threshold amounts are as follows:
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$200,000 for single filers
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$250,000 for married filing jointly
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$125,000 for married filing separately For trusts and estates, the 3.8 percent surtax is imposed on the lesser of:
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The undistributed net investment income for the tax year; or
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The excess (if any) of the taxpayer's adjusted gross income over the dollar amount at which the highest tax bracket begins ($11,200 in 2013). Net Investment Income Defined Net investment income includes the following, reduced by any deductions allocable to such income:
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Interest, dividends, royalties, annuities, rents
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Income derived from passive activities
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Trading financial instruments and commodities
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Net capital gains derived from the disposition of property, other than property held in an active trade or business Net investment income does not include:
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Active trade or business income
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Gain or sale on an active interest in a partnership or S corporation
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Distributions from IRAs or qualified retirement plans
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Income from tax exempt municipal bonds
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Tax deferred non-qualified annuities
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Income taken into account for self-employment tax purposes
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Capital gain excluded under I.R.C. §121
To determine whether any tax planning strategy mentioned is appropriate for your specific circumstances, contact your KKAJ tax and accounting professional at (818) 848-5585.
Mixing Business With Pleasure
by Thomas Engman, CPA, Partner
There's an old adage to "never mix business with pleasure." According to the IRS, if you're either self-employed or an employee with unreimbursed travel expenses, traveling within the United Sates and follow a few tax-smart strategies, you can mix business with pleasure and deduct most of your expenses.
If you're traveling on business within the United States and want to add a few extra days of vacation onto your itinerary, you may want to plan your trip with some smart tax strategies in order to maximize your deductions.
It's an all or none proposition. If the primary reason for your trip is business, rather than personal pleasure, the IRS guidelines allow self-employed individuals to deduct 100 percent of their transportation costs for travel. Transportation expenses include plane tickets, the cost of getting to and from the airport at both ends of the trip, and luggage handling tips. The same rules apply if traveling by car or rail. However, if vacation is the primary motivation for your travel, you can't deduct any of your transportation expenses, even though you may conduct substantial business during the trip.
How do you determine if the purpose of a trip is primarily for business or pleasure? There are no concrete rules but you can claim a trip is mainly for business when your business travel days exceed your personal travel days.
Business days include travel days, days spent working during normal business hours, and weekends and holidays that fall between business days, as long as it is impractical for you to return home on those days. Standby days when a customer or client requests that you stick around just in case you are needed count, as do days that you intended to work but could not for reasons beyond your control. Be sure to keep good records and a log to chronicle all your business activities, including the date and amount of time spent on each one.
While traveling, you can also deduct all your out-of-pocket expenses for business days during your trips. Hotel bills, cab fares, and seminar fees are fully deductible; deduct 50 percent of your meal costs for business days. Out-of-pocket expenses for personal days are generally nondeductible, unless there's a Saturday night stay-over. If staying over on Saturday night reduces the airfare for your business trip, you can deduct the out-of-pocket cost of staying the extra time even though you spend it vacationing, as long as the extra cost of the stay-over is less than or equal to your airfare savings.
If your spouse joins you on your trip, you can't deduct their airfare unless they are an employee of your business. But you can take a deduction on the hotel bill. You can write off the cost of what you would have paid traveling alone, the single room rate rather than the double. As an example, if the hotel charges $150 for a double room and $120 for a single, you can deduct the $120 rather than half of the double rate ($75). To prove your deduction, ask the hotel for a room rate schedule showing single rates for the days you're staying.
If you're packing the whole family into the car for a combined business-vacation trip, you can deduct the total cost of driving back and forth since you would have incurred the same expenses if you were traveling alone.
Map out a tax-smart strategy before your next business trip and you may just be able to spend a few extra days on the golf course or at the beach. Safe travels.
KKAJ Welcomes New Employees
If you've heard a new voice on the line when calling KKAJ lately, chances are you've been greeted by the firm's newest addition, Diane Riveros. Diane started with KKAJ in September as an Administrative Assistant. Raised in Palmdale, Diane currently resides in Pasadena with her husband; they were married only a few weeks before Diane started her new position.
Remarking about the family culture at the firm, Diane notes the significant difference between the work environment at KKAJ and that of her previous employer, a large-sized financial institution. "In my previous job, there was always change of personnel and you were lucky to recognize a face or two. Here, everyone knows your name and is very nice."
During her free time, Diane enjoys playing sports and spending time with her nieces and nephews. In fact, Diane and her husband are already on the KKAJ roster in the City of Burbank Co-ed Corporate Softball League. Go KKAJ blue!
Born and raised in South Jordan, Utah, Daniel Holbrook joined KKAJ as a Staff Accountant in late summer. Daniel graduated from Brigham Young University in April 2011, earning a Bachelor of Science and Masters in Accounting. In addition, he has eight years experience with the National Guard to add to his resume.
When Daniel was recruited from the BYU campus, he noticed in the interview process how much people really enjoyed working at KKAJ. "I like getting a taste of everything," Daniel said regarding the variety of work assignments he receives in his position.
When not busy working or studying for the final segment of the CPA exam, Daniel enjoys running, hiking and mountain biking. He and his wife reside in Woodland Hills.
In addition to college recruiting, KKAJ hires through referrals and other sources. To learn more about career opportunities, contact Louis Hamel or Bob Jensen at (818) 848-5585.
Team KKAJ Wins Burbank Basketball Championship
You typically don't expect a group of affiliated accounting professionals to trade in their conservative work clothes for matching athletic jerseys. But that's exactly what KKAJ Partner Louis Hamel, staff members Mark Berkowitz, Mike Garrison, Chris Kim, Evan Faucette, and friends Chris Olson and Kyle Christensen do every week.
Now in their third season and currently undefeated, the KKAJ basketball team recently won the Summer 2011 season in the City of Burbank's Adult Sports League, Silver Division.
"We may not be the most athletic team on the court," said team captain Mark Berkowitz, "but what we lack in athleticism we make up for with our ability to communicate and work together as a team."
Work hard, play hard. The team cites the camaraderie and team building benefits that playing together has brought to the firm. Families and co-workers share in the excitement by cheering the team on from the stands.
Although the league has three seasons per year, the KKAJ team will go on hiatus at the end of the Winter season to accommodate their busy tax season.
KKAJ Earns Distinction as "Best Places to Work"
Rankings for the 75 Best Places to Work in Los Angeles were unveiled at an awards luncheon on August 9. KKAJ earned the distinction of making the list in the Small Companies category (15 - 49 employees).
The Best Places to Work in Los Angeles is an annual celebration of elite employers who have proven that they know what it takes to create environments where people love to come to work.
KKAJ was acknowledged for its guiding principles and core values, which include trust, respect, quality and loyalty. Maintaining a friendly atmosphere, extensive benefits, long-term client relationships, wide variety of experience for entry-level professionals and the ability to advance within the company were also noted.
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