Tax talk

Tax Talk

How to Plan for the Coming Tax Increases and Steps to Take to Reduce Audit Risk

Daniel S. Gordon, CPA

The Government Needs Money! The short term solution

will be to enforce the current tax rules and to raise taxes. The result for the business owner will be to operate in a business environment where the likelihood of tax audits will rise as well as be subject to increasing tax rates.

Agenda

Background Payroll Tax Holiday Expired Healthcare Act American Taxpayer Relief Act of 2012 Record keeping

Background

Speaker of the House Tip O’Neill, an old-time Democratic politician from Massachusetts, would say all kinds of mean things about President Reagan. But rather than get angry or carry a grudge, the President invented a rule that Tip could say whatever he wanted during the day, but at 6 PM, the politics would stop and they would be friends. Nothing told the story of Ronald Reagan’s magnanimity more than pictures of those two old Irishmen swapping stories and laughing uproariously in the evening after a day of pretty intense verbal assaults.

Background

Enemies

Obama campaigned on a platform to raise taxes on the wealthiest Americans, declaring that millionaires and billionaires need to "pay their fair share."

Romney at a May fundraiser, declaring that 47 percent of the population is made up of people who believe they are “victims,” and are “dependent on government.”

Background

Congress ended 2012 with a 15 percent average approval rating -- its lowest yearly average in history, according to Gallup. The legislative branch of government began 2013 with a 14 percent approval rating, Gallup found.

So Politics in America are still broken but:

On January 1, 2013 by a vote of 89 to 8 the US Senate approved the American Taxpayer Relief Act of 2012 where it was sent to the House of Representatives and passed by a margin of 257 to 167 and signed by the president

Background

We may not like it but at least we now know the Rules

Because of the last minute nature of the passage of the law, Tax Preparers have been delayed in when they can start E-Filing Tax Returns because many of the tax forms need to be updated

Rules

Background

Payroll Tax Holiday Expired

The Government Giveth then Taketh Away - Payroll Tax Cut

On December 17, 2010 President Obama signed a multi-billion dollar tax cut package, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010.

Payroll Tax Holiday Expired

The Government Giveth then Taketh Away - Payroll Tax Cut

One of the Provisions reduced the employee-share of Social Security tax from 6.2% to 4.2% for wages earned in calendar year 2011 up to $106,800 – a maximum savings of $2,136.

Similarly, the Social Security portion of the self-employment tax dropped from 12.4% to 10.4%.

This was a 2% raise to all employees and owners who are subject to self employment tax (Most everyone in your company including yourself).

The Payroll Tax cut was extended for tax year 2012

Payroll Tax Holiday Expired 

It was meant to be temporary and Spur on the Economy

In fairness it wasn’t an income tax but rather funding Social Security

Beginning in 2013 the Holiday is Over 

The result is that the average household making $50,000 a year will pay an extra $1,000 this year in taxes.

Payroll Tax Holiday Expired

Tax The Rich?

Consider this:

The wage earner making $50K will pay $1,000 or 2% of his Salary from this tax.

The wage earner making $1million will pay $2,274 or .223% of his salary

The Patient Protection and Affordable Care Act commonly called Obamacare. Tax Provisions relating to Obamacare for 2013:

3.8% Medicare Contribution Tax .9 additional Medicare Tax $2500 contribution Limit on Health Flexible Spending Accounts Increase Threshold for Itemized Medical Expenses

Healthcare Act

Medicare Contribution Tax 

The Affordable Care Act imposes a 3.8 percent Medicare contribution tax on the unearned income of higher-income individuals, estates and trusts effective January 1, 2013.

The Medicare contribution tax applies to net investment income (NII), and will generally apply to passive income. The Medicare contribution tax also applies to capital gains from the disposition of property.

For individuals, the Medicare contribution tax will apply to the lesser of the taxpayer’s NII o r the amount of “modified” adjusted gross income above a specified threshold.

S-Corp Exception

Healthcare Act

Additional Medicare Tax The Affordable Care Act also imposes an additional 0.9 percent Medicare tax on higher income individuals, effective January 1, 2013.

The additional Medicare tax applies to total wages, other compensation, and self employment income that exceeds the applicable threshold amount for the individual’s filing status.

Healthcare Act

Definition of Higher Income Individuals for Medicare Contribution Tax and Additional Medicare tax is:

Modified Adjusted Gross Income of $200,000 for a Single, $250,000 for Married Filing Jointly and $125,000 for Married Filing Separately

Healthcare Act

Itemized Deduction for Medical Expenses For tax years beginning after December 31, 2012, the Affordable Care Act increases the 7.5 percent threshold for itemizing medical expenses to 10 percent.

However, the Affordable Care Act temporarily exempts individuals age65 and older from the 10 percent threshold. 

Healthcare Act

 Health Flexible Spending Arrangements After 2012, the Affordable Care Act caps the maximum salary reduction contribution to a health flexible spending arrangement (health FSA) at $2,500.

Salary reductions in excess of $2,500 will subject the employee to tax on distributions from the health FSA. The $2,500 limit will be indexed for inflation for tax years beginning after December 31, 2013.

Healthcare Act

American Taxpayer Relief Act of 2012

Individual Income Tax Rates on Ordinary Income: Starting in 2013, the 10%, 15%, 25%, 28%, 33% and 35% tax brackets

would remain in place.

There would be a new 39.6% rate, which would begin at the following thresholds:

• Married Filing Jointly: $450,000 of taxable income • Qualifying Widow(er): $450,000 of taxable income • Head of Household: $425,000 of taxable income • Single: $400,000 of taxable income • Married Filing Separately: $225,000 of taxable income

American Taxpayer Relief Act of 2012

Tax Rates on Long-Term Capital Gains:

The law retains the zero percent tax rate on long-term gains, modifies the 15% rate, and proposes a new 20% rate.

Starting in 2013 the tax rates on long-term gains would be:

• 0% if income falls below the 25% tax bracket

• 15% if income falls at or above the 25% tax bracket but below the new 39.6% rate

• 20% if income falls in the 39.6% tax bracket

American Taxpayer Relief Act of 2012

Qualified Dividend Rates: Since 2003, taxpayers have enjoyed a maximum tax rate of 15 percent on qualified dividends received by individuals

The Act permanently extends the 15 percent dividend rates for most taxpayers.

But the Act adds 20 percent dividend rate, the same as the Capital Gains Rate for taxpayers with annual income in excess of the income tax threshold amounts described on the prior slide

American Taxpayer Relief Act of 2012

Limitations on Itemized DeductionsItemized deductions will be reduced by the lesser of 3% of the taxpayer's adjusted gross income (AGI) over the threshold amount or by 80% of otherwise allowable itemized deductions.

The threshold amounts at which itemized deductions would start to be limited are:

Married Filing Jointly: $300,000 of AGI Qualifying Widow(er): $300,000 of AGI Head of Household: $275,000 of AGI Single: $250,000 of AGI Married Filing Separately: $150,000 of AGI

These threshold amounts would be indexed for inflation for years after 2013

American Taxpayer Relief Act of 2012

Limitations on Personal Exemptions:The personal exemption will be phase-out starting in 2013.

Taxpayers would see their total personal exemptions reduced by two percent for each $2,500 (or fraction thereof) by which adjusted gross income exceeds the threshold. The threshold amounts for 2013:

Married Filing Jointly: $300,000 of AGI Qualifying Widow(er): $300,000 of AGI Head of Household: $275,000 of AGI Single: $250,000 of AGI Married Filing Separately: $150,000 of AGI

These threshold amounts would be indexed for inflation for years after 2013.

American Taxpayer Relief Act of 2012

Deductions, Credits, and Income Exclusions:

The following tax provisions are extended through the end of the year 2017:

American Opportunity Credit Child Tax Credit at $1,000 maximum and partially refundable Earned Income Credit for 3 or more dependents Others

American Taxpayer Relief Act of 2012

The following provisions are extended through the end of 2013: Educator expenses deduction Exclusion for cancellation of debt on primary residences Mortgage insurance premium deduction Deduction for state and local sales taxes Tuition and fees deduction Others

American Taxpayer Relief Act of 2012

Business Provisions:

Section 179 Expensing of New Assets – 2012 and 2013 Limits are $500,000 with a $2,000,000 investment limit.

This is probably the one provision that positively impacts our firms as the 2012 and 2013 limits were moving down significantly.

Observation: 2012 is closed so the planning opportunity is gone

American Taxpayer Relief Act of 2012

Bonus Depreciation:

50% Bonus Depreciation also extended through 2013.

American Taxpayer Relief Act of 2012

Built In Gain for C Corps that have converted to S Corps:

5 Year Period Extended thru 2013

Will revert back to 10 years in 2014 unless the law is modified

American Taxpayer Relief Act of 2012

Record KeepingWe need to maintain accurate financial records. The most obvious reasons for doing so:

To assess the results of operations against past periods, current budgets, or to formulate future projections.

However, there is an external partner in your business that needs to be fed accurate information and if that partner requests, you as an owner/manager must prove the accuracy of the information

If you are wrong or can’t prove that the information is accurate, you may be subject to fines. So who is this partner?

Well actually, there are several; and they are the IRS, and the state and local taxing authorities.

Record Keeping

Essentially, you are responsible for providing these taxing authorities financial statements that summarize the results of your operations in order to report tax liabilities as well as provide payment of taxes.

Depending upon the type of legal entity you operate, you may be required to provide a Balance Sheet as well as a Profit and Loss statement.

It’s your responsibility to be able to support each and every number on your tax return with collaborating documentation.

Record Keeping

Sounds like a lot of work

And it is….

The problem is that we get so involved with running our businesses that many times we put record keeping on the back burner and do a mad dash at tax time to organize our records.

A small business has many moving parts

These issues make the bookkeeping function an extremely important task that is required frequently rather than only at year end.

Record KeepingSo What Records are required?:

The IRS does not have a prescribed recordkeeping system. You may choose any recordkeeping system that suits your needs as long as it clearly shows your income and expenses.

Your recordkeeping system should also include a summary of your business transactions. This summary is primarily the ledgers that are part of your accounting system.

Most businesses that I work with use QuickBooks for their general ledger requirements. It provides adequate detail when drilling into sub ledgers. As long as the transactional information is accessible, accurate and detailed enough to trace and agree to a source document, a small business will fare well in the data presentation phase of an audit.

Record Keeping

Assuming your ledgers are correct, each transaction needs to be supported by a source document (By the way these documents may be electronic).

Purchases, sales, payroll, and other transactions will generate supporting documents such as invoices, receipts and other supporting documents.

These documents contain the information that must be recorded in your ledgers. It is important to keep these documents because they support the entries in your books and on your tax return.

You should keep them in an orderly fashion and in a safe place. For instance, organize them by year and type of income or expense.

Record Keeping

Important Point: A record not only needs to be verifiable, but it must support a transaction that is includible in income or deductible as an expense as allowed by the tax code and regulations promulgated there under.

In other words just showing you paid an item is not sufficient.

It must be necessary and reasonable supporting a business purpose in order to be deductible.

Record KeepingHere are some basic records that substantiate the following items:

Gross receipts are the income you receive from your business. You should maintain supporting documents that show the amounts and sources of your gross receipts.

Documents for gross receipts include the following: Signed Service Tickets or Invoices Bank deposit slips Credit card charge slips Forms 1099-MISC received from customers

Record KeepingPurchases are the items you buy and resell to customers or materials you apply during your service visits.

Your supporting documents should show the amount paid and that the amount was for purchases.

Documents for purchases include the following:Vendor Invoices for Chemicals, Supplies and EquipmentCancelled ChecksCredit card sales slips

Record Keeping

Expenses are the costs you incur (other than purchases) to carry on your business.

Your supporting documents should show the amount paid and that the amount was for a business expense.

Documents for expenses include the following: Cancelled checks Legal Agreements such as leases, note payable, mortgages etc. Account statements Credit card sales slips Vendor Invoices Petty cash slips for small cash payments

Record Keeping

How long should I retain records?

The minimum amount of time to retain records for tax purposes depends on the item, when it is recorded and if it will be part of a future transaction (for example, a if you purchase a vehicle and sell it in 5 years. The transaction 5 years hence would be a future transaction that information from the original purchase would be needed).

Generally, you must keep your records that support an item of income or deductions on a tax return until the statute of limitations for that tax return runs out.

Record KeepingThe statute of limitations is the period of time in which you can amend your tax return to claim a credit or refund, or that the IRS can assess additional tax – usually three years after filing.

In the following situations you will need to produce records past the normal statute of limitations:

You will need to produce your records for up to six years after filing if you fail to include income that you should have reported, and it is more than 25% of the gross income reported on the original return.

You will need to produce your records for up to seven years after filing if you file a claim for a loss from worthless securities or bad debt deduction.

Record Keeping

Keep all employment tax records for at least 4 years after the date that the tax becomes due or is paid, whichever is later.If you file a fraudulent return or you don’t file a return, your records may be examined indefinitely.

Keep records relating to property purchases and improvements until the statute of limitations expires for the year in which you dispose of the property. These records must be kept to figure any depreciation or amortization and to figure the gain or loss when you sell or dispose of the property.

Record Keeping

Conclusion:

A successful business person needs to keep accurate and complete records that are supported by a well maintained bookkeeping system.

The benefits of doing so, allows and owner/manager to perform proper planning for growth and profit.

Just as important though it also allows an owner/manager to comply with any requests for records during an IRS audit should you be called on to prove your tax return is accurate.

Record Keeping