Trumped on Taxes

One era ends and a new one begins, which is a happy or sad thing, depending on which side of the aisle you sit on.  Regardless of where you stand (or sit) on the prospect of Donald Trump becoming our next president on January 20th, one thing will be sure; he’s going to look to shake up the tax code.  Depending on how much he gets his way, your 2017 tax picture could look very different from your 2016 one.  Let’s take a quick look at some possibilities.

Tax Rates – whether it’s Mr Trump or Congress, the Republican majority will look to cut tax rates in some fashion.  Lower tax rates mean that any deductions you have will get less bang for the buck, in the form of income tax savings.  For example, if you’re in a 25% marginal tax bracket and have itemized deductions of $10,000, the deductions will save you $2,500 in federal tax (deduction amount times the tax rate).  If tax rates are reduced and you drop to a 20% marginal bracket (I’m just making up that rate), your same $10,000 of deductions will only save you $2,000 in tax.  The bottom line is that for those of you who claim itemized deductions for charity, state & local taxes, and mortgage interest, a reduction in tax rates means that you’ll save less in income tax.

Charitable contributions – because tax rates could go down (and your income tax savings for making charitable contributions could be reduced), you might want to consider accelerating any donations that you were going to put off to 2017, and make them before the end of 2016.  If you have any securities that have appreciated in value, making a donation of the appreciated securities is a great way to avoid the potential capital gain income on a sale, and get a deduction for the current value of the security.

State & local taxes – I’ve personally seen less people get a tax benefit for these, as more of my clients have wound up in the Alternative Minimum Tax (AMT).  In the AMT computation, state & local taxes are disregarded as a deduction.  If you’re not in the AMT, prepaying by December 31 any state estimated tax payment that you’d otherwise make by January 15 would save a few dollars in 2016, and with possible lower rates in 2017, you’d have lower income tax savings in 2017 anyway.

Capital gains – while Mr Trump’s plan would retain the current long-term capital gains rates of 0%, 15%, and 20%, the threshold for hitting the top rate would be reached a lot faster, which means that long-term gains would be taxed at 20% starting at about $225K of taxable income on a joint return (vs about $467K now) and $112K of taxable income on a single return (vs about $415K now).  This would seem to indicate that if you’re considering selling any investments at a long-term gain, and expect to have a pretty high taxable income, it would be better to sell before the end of 2016. But…the other consideration is the current 3.8% net investment income tax, which is a tax on interest and dividend income, and capital gains.  If adjusted gross income is above certain levels, this tax kicks in.  Mr Trump and Congress both want to eliminate the net investment income tax.  It then becomes an exercise of figuring out whether gains will net out a higher total of capital gain + net investment income taxes in 2016, or possibly only capital gain tax (potentially at a higher rate) in 2017.  You gotta admit, isn’t this fun stuff?!

These are just a few points to ponder, while you’re slugging it out and standing in line at the mall this holiday season.  As always, if you need some tax number crunching done, consult your favorite CPA!

Investing and Backdoor Taxes

It’s been a pretty good year so far for the stock market, and you may have locked in some nice capital gains on investment sales, and/or received some hefty dividends from mutual funds (or may yet receive year end fund distributions). While all of this is good stuff (more money in your pocket), the additional gains and income could put you in the position of paying even higher taxes than you may anticipate.

In my practice, this past tax season was a “perfect storm” for a bunch of my clients, who got hit with additional/higher taxes, as well as the loss of various deductions. Let me run down a few things from last year that are still lurking out there this year.

Net Investment Income Tax – this was a new tax in 2013, and is a 3.8% tax on income such as capital gains, dividends, interest, and a few other items. Once income goes above certain levels, this additional tax will kick in.

Personal Exemption Phaseout – while this isn’t an additional tax per se, the fact that personal exemptions (for self, spouse, dependents) can be reduced literally to zero if income is high enough, which has the effect of raising taxable income, obviously creating a higher tax.

Itemized Deduction Phaseout – this works similarly to the exemption phaseout, in that when income is high enough, itemized deductions will be reduced. And as with the exemption phaseout, this exposes more income to taxation.

Higher Long-Term Capital Gains Rate – for taxpayers in the top tax bracket, long-term capital gains will be taxed at 20% and not 15% for most other taxpayers.

Alternative Minimum Tax – I’ve covered this in previous articles, but it’s something that’s also still hanging around, and shouldn’t be forgotten.

From a tax planning perspective, if you feel some or all of these could be applicable to you in 2014, and you don’t want surprises at tax time, I recommend that you contact your favorite CPA (maybe one whose name starts with “Jay The…”?) to crunch some numbers and get some additional guidance on ways to reduce the sting of some of these stealth taxes.

Holidays and Tax Planning

Thanksgiving is history. Black Friday’s gone. Cyber Monday’s in the books. What’s there to look forward to? The second half of Hanukkah? Christmas? Are you kidding, we’re talking tax planning, people!

That’s right, rather than thinking about ways to spend money, think about ways to save money, especially on taxes. Since there’s about a month left in 2013, you still have a little time to save a few dollars in tax before the ball drops in Times Square.

Net Investment Income Tax – starting with the 2013 tax year, taxpayers with adjusted gross income (AGI) over $200K single/$250K married filing jointly are subject to an additional tax of 3.8% on net investment income above the threshold amounts. This tax applies to income that includes capital gains, interest, dividends, rents, and others. While some of these items may be beyond your control (such as how much dividend is paid on a stock or mutual fund), you may be able to control your AGI, to keep it below the threshold where the 3.8% tax kicks in. One way is if you’re taking retirement plan (IRA etc) distributions. If you’re considering taking more than a minimum distribution, consider whether a higher distribution would put you above the level where the 3.8% tax kicks in.

Personal Exemption Phase-out – this “gem” has been (thankfully) missing from tax returns for the last three years, but has come roaring back for 2013. For AGI over $250K single/$300K joint, the deduction for personal exemptions reduces (phases out), and goes down to zero with AGI of about $372K single/$422K joint. Taxpayers closing in on the phase-out range of AGI should consider if there are ways to push off 2013 income to 2014, to keep personal exemptions intact.

Itemized Deduction Phase-out – similar to the personal exemption phase-out, the reduction of itemized deductions returns in 2013. Common itemized deductions are mortgage interest, real estate tax, charitable contributions, and others. As with the exemption phase-out, when AGI goes above the thresholds, the total allowed itemized deductions begin to reduce. Note that reduced deductions and exemptions have the effect of subjecting more income to tax, which has the effect of increasing your overall net tax rate.

As you may have concluded, the tax and phase-outs I mentioned above are driven by your level of AGI, so it’s important to look at ways to reduce your adjusted gross income. The best way to address this is to look at page 1 of your 2012 tax return, since the page 1 ends at AGI. Consider if there are ways of delaying income, taking losses on investments (which would reduce income/AGI up to $3K), switch investments to tax free municipal bonds/funds, and increasing retirement plan contributions, among other things.

While increasing itemized deductions won’t reduce your AGI, they will still probably net you some tax savings. Making additional charitable contributions could help, as would bunching medical or miscellaneous itemized deductions, both of which are subject to AGI related “floors”.

So while you’re in the middle of a tug of war with that jerk at Walmart over the last Xbox 360 on the shelf, just think about how much more fun it would be to save some money on your taxes!

How are you planning on saving on your taxes this year? Or next? Leave a comment and let me know what you’re thinking. And please forward this article to a friend or family member who might (tax) benefit from it.

Home Sales and Taxes

With the housing market as hot as it’s been, you may be thinking of selling a home, and hopefully taking the profit and running. But will you owe any taxes to Uncle Sam? The short answer is, it depends (hey, nothing’s ever straightforward when it comes to taxes!) This article will discuss various aspects of home sales and taxes.

Principal Residence?

If the home being sold is your principal residence, up to $500K of gain on the sale can be excluded from tax on a married joint return ($250K for a single taxpayer). Note that this is gain on the sale, which is generally the difference between the selling price and the cost basis of the home. Also remember that this is for the place that you call home, normally your primary residence, and not a second or vacation home. The exclusion can be claimed if you’ve lived in this residence for at least two of the previous five years. If you don’t meet the two year requirement due to certain specific unforeseen circumstances, a reduced exclusion can be available.

Rental Property?
Do you live in a home that’s also partially rented out to somebody else? If you do, the two parts (residence and rental) need to be split into two transactions for tax purposes, and only the residence part is subject to the gain exclusion. Any gain on the rental portion will be 100% taxable.

3.8% Medicare Tax

For tax years starting in 2013, there’s a 3.8% Medicare tax on “net investment income”, and I’ll give you one guess what gets included in this computation. The good news is that if the principal residence exclusion amount wipes out your gain on sale, you won’t be subject to the 3.8% tax either.

Sale of Principal Residence at a Loss

Sorry, this one just isn’t deductible, period, end of story. The story has a different ending if it’s a property you rented out to others, but that’s beyond the immediate scope of this article.

Home Office Depreciation

If you took depreciation deductions on a home office, this will reduce the basis of your home, for purposes of computing the gain on sale. Not only that, but the amount of depreciation taken in previous tax years will be recaptured on sale as taxable income, and also be subject to the 3.8% Medicare tax.

Obviously there are lots of non-tax related things to think about when selling a home (moving, for one), but don’t lose sight of the tax laws surrounding the sale, because if you do, you may have a nasty surprise come tax time. My recommendation is to speak with your favorite CPA (hint hint) and do some pre-sale tax planning.

Please forward this article to anybody you know who is considering selling a home, and if you have any personal stories or comments about home sales and taxes, please leave a comment.

Cliff Diving 101

Who needed to watch the ball drop in Times Square, if you were looking for New Year’s Eve excitement? We had Congress giving us plenty of excitement (and heart attacks) with their dillydallying about the “fiscal cliff”. For better or for worse, the American Taxpayer Relief Act of 2012 was signed into law on January 2, 2013, and thank you very much, but I’ll stay out of any political discussion as to whether it’s good or bad for American taxpayers. What I will do is summarize a few of the key provisions of the “Act”, for your reading pleasure/misery.

Individual Income Tax Rates

The Act retains the 10%, 15%, 25%, 28%, and 33% marginal tax rates that had been in effect previously. The 35% tax bracket will end at $400K of taxable income (single) and $450K taxable income (joint). Above those thresholds, the 39.6% rate that was in effect “pre-Bush-tax-cuts” will kick in.

Estate and Trust Tax Rates

The top rate for estates and trusts rises to 39.6%, for taxable income over $11,950. As you can see, the top tax rate kicks in at a comparatively low taxable income amount, so executors and trustees are advised that whenever possible/practical, the income should be distributed out of estates/trusts to beneficiaries, especially when the beneficiaries are in a lower tax bracket than the estate/trust.

Long-term Capital Gains and Qualified Dividends

In recent tax years, long-term capital gains and qualified dividends have generally enjoyed a relatively low 15% tax rate. This will continue under “The Act”, but (always a but, eh?!) in cases where taxpayer’s taxable income (including the gains and the dividends) exceeds that magic threshold of $400K single/$450K joint, long-term gains and qualified dividends will be taxed at 20%.

15% Tax Rate Bracket for Joint Filers

The size of the 15% bracket for joint filers remains at 200% of the size of the 15% bracket for single taxpayers. Before all you single taxpayers run off to get married, keep in mind that this 200% amount does not apply to higher brackets, and remember what as I said above, about the top 39.6% bracket for joint taxpayers being only $50K higher than it is for single taxpayers, so there will definitely be some “marriage penalty” effects.

Standard Deduction For Joint Filers

The standard deduction for joint returns will remain at 200% of the standard deduction for single taxpayers, woo hoo!

Itemized Deduction Phase-Outs

This is something that we haven’t had to face for a few years, and it’s baaack! Beginning in 2013, when Adjusted Gross Income, (not taxable income) exceeds $250K single/$300K joint, itemized deductions will generally be reduced by 3% of AGI. The net effect here is to actually increase your effective tax rate. It’s been estimated that taxpayers in the 33% bracket will effectively pay 33.99%, those in the 35% bracket will effectively pay 36.05%, and those in the 39.6% bracket will effectively pay 40.79%!

There are a lot more provisions to the Act, but I think I’ve been more than sadistic enough by telling you about the items above. For CPAs like me, each of these tax acts should really be called “The Tax Preparer Job Security Act”, since it keeps all of us busy, sorting through provisions, and advising our clients.

Questions? Comments? Gripes? Feel free to leave a comment. Stay tuned for more “stupid Congress tricks”!

A Capital Idea…Gains and Losses

Now that we’re in the thick of tax season, I want to briefly discuss a topic that affects many taxpayers in this country, capital gains and losses. In my 11/7/11 post, I wrote briefly about the new reporting requirements for both brokers/mutual funds, and taxpayers. In this article, I’d like to discuss in a little more detail exactly what constitutes capital gains or losses.

Did you know that almost everything you own and use for personal purposes, pleasure, or investment is considered a ‘capital asset’ for tax purposes? Well now you know (that, and $2.50 will get you on the NYC subway!) Capital assets include a home, household furnishings, and stocks & bonds, among other things.

When you sell a capital asset, the difference between what you paid for the asset (its basis) and its sales price is capital gain or capital loss. Here’s the fun part…you must report all capital gains. Now here’s the bad part…you may only deduct capital losses on investment property, not on personal-use property. What this means is that you can deduct the loss you had on the sale of your Worldcom stock, but you can’t deduct the loss on the sale of your Ford Pinto.

Capital gains and losses are classified as long-term or short-term, and this is important, since the tax rate on long-term gains is generally 15%, while short-term gains are taxable at your marginal tax rate, which can go as high as 35%. In order to be classified as long-term, the capital asset must have been held more than one year (e.g. a year and a day, or more).

All capital gains and losses are netted out to figure out what needs to be included in your taxable income. If everything nets out to a loss, you can deduct the excess losses on your tax return to reduce your other income (wages, interest, dividends, etc), but there’s an annual limit of $3,000 that can be used. For the unfortunate taxpayers who had huge losses on stocks from the last market crash, the excess of the $3,000 that can be deducted annually can be carried forward and applied in subsequent tax years until used up. If, in subsequent years you have capital gains, the losses that were carried forward can be applied against the capital gains, dollar for dollar.

As I mentioned in my 11/7/11 article, IRS created Form 8949 which must be used starting with 2011 returns, to report capital gains and losses. The totals on the 8949 forms then get carried over to Schedule D, and ultimately on to the 1040.

I hope this helps with your understanding of capital gains and losses, if you were fuzzy about them previously. I welcome any comments you may have on this subject, and please pass along this article to friends, enemies, colleagues, or somebody who could use some extra tax knowledge on what might otherwise be a mundane day!