Federal Tax Update & Planning Opportunities
At this quarter's CFO roundtable, Margaret Amsden and Sue Tuson discussed federal tax law and planning opportunities to be considered. Shortly after the roundtable, on September 27, 2010, The Small Business Jobs Act of 2010 was signed by President Obama. Summarized below are some of the key points of the conversation, including updates for items that have changed as a result of this recent legislation.
Expiring Tax Provisions
- Individual tax rates are increasing in 2011. This includes the graduated ordinary tax rates, capital gain rates, and dividend rates (Tax rates summary)
- Many more taxpayers will be subject to the Alternative Minimum Tax because the exemption has decreased from $46,700 for single filers and $70,950 for married filers to $33,750 and $45,000, respectively
- Bonus depreciation, which had expired as of December 31, 2009, has been extended through the end of 2010, allowing businesses to expense 50% of the cost of acquired assets in the first year
- The Section 179 limit was also changed. The expense limit for assets acquired during either 2010 or 2011 has increased to $500,000. This limit will now be reduced if total assets acquired reach or exceed $2 million, a much higher limit than under prior law
This Act also allows a zero tax on capital gain from key small business investments held over 5 years, a health insurance cost deduction against self employment income, simplification for cell phone deductions, an increase in the deduction for start-up expenditures to $10,000, and a 5-year carry back of general business credits.
Health Insurance Reform
- Coverage for dependents through their parents insurance is now available until the dependent reaches the age of 26
- Beginning in tax year 2013, medical expenses will be deductible to the extent they exceed 10% of a taxpayers adjusted gross income. The current threshold is 7.5%
- The Medicare tax will increase by 0.9% in 2013 on income earned above $200,000 for single filers and $250,000 for married filers. The new tax on unearned income of 3.8% will result in the Medicare tax being collected on the investment income of these same individuals in 2013 and later
- Beginning in tax year 2011, information reporting will increase for most companies because Form 1099s will be required to be filed for all payments aggregating $600 or more to a single payee including corporations. There is an exemption from the filing requirements for payments to tax exempt corporations. In addition, businesses will need to report employees' health insurance costs paid by the employer on Form W-2
Estate Taxes
- The estate tax has been repealed, and there is no estate tax for 2010. This means basis in assets will not automatically receive a step up and may be difficult to determine
- Current law will revert the exemption and tax rate back to 2001 levels of $1.0 million and 55%
- Estate planning is a crucial consideration
- Estate tax uncertainty
IRA Conversions
- In 2010, income limitations on converting a traditional IRA to a Roth IRA no longer apply
- The benefits to a conversion include taking advantage of favorable tax attributes, eliminating the required minimum distribution upon age 70½ years, allowing greater wealth to be transferred to future generations, allowing greater growth potential, effectively reducing the taxable estate of an IRA owner, and hedging against the projected increase in tax rates
The recently passed Small Business Jobs Act of 2010 also expands the rollover provisions to qualified retirement plans including 401(k), 403(b) and 457(b) plans. The rollover is done within the plan. It should be noted that to allow for these rollovers, the plan may need to be amended.
Tax Strategies
A sample individual income tax projection was distributed and discussed. In the example shown, a taxpayer earning $725,000 annually would pay $224,058 of tax in 2010, $250,227 in 2011, and $258,077 in 2013.
Some strategies to mitigate the pending increase in tax rates in future years include:
- Accelerating income into 2010
- Delay expenses until 2011
- Electing out of the installment reporting for capital gains in 2010
- Capturing capital gains and deferring losses in 2010
- Cleaning up the balance sheet
- Paying dividends in 2010, either from C Corporations, or considering a distribution of prior C Corporation E&P held by an S Corporation
International Issues
The Education/Jobs/Medicaid Assistance Act signed August 10, 2010, made many changes to the foreign tax credit rules. These changes include:
- Elimination of foreign tax credit splitting
- Reduction of foreign tax credits on stepped up assets
- Restrictions on treaty use to resource U.S. income
- Limitations on the use of IRS 956 on deemed dividends
- Repeal of the 80/20 rules
The HIRE Act made changes in the requirement for foreign asset reporting including:
- For tax years beginning after March 18, 2010, individuals with foreign financial assets with a total value of $50,000 or more must disclose the assets on a statement attached to their individual tax return
- Individuals who fail to file this disclosure are subject to a $10,000 penalty for the tax year and a penalty equal to 40% of the amount of the understatement
In summary, there are many issues to consider regarding federal income tax planning, and we expect more potential law changes to come. We will keep you informed as new legislation is signed into law.
