More Tax Change? by Carolyn Flaherty

A quick review of the history of the United States income tax from the vantage point of personal income taxes, (not to mention the estate and gift tax, partnership & corporate taxation, etc.), reveals that the mind numbing technological revolution that has brought us from the advent of the personal computer in the 1970's to today's broad use of smart phones, tablets and touch screen technology in a mere 5 decades is occurring along side a less heralded tax revolution.

Many of you would be shocked to know that before 1913 our fine country was financed almost exclusively via tariffs on imported goods. In fact, the legality of federally collected personal income tax was largely questioned until the passing of the Sixteenth Amendment to the Constitution in 1913. The Sixteenth Amendment explicitly grants Congress the right and the power to collect tax on personal income.

Since 1913 the Tax Code has been reformed, and some would say complicated, at a stunningly frequent pace. Indeed in the past 10 years alone it is estimated that the Code has been revised approximately 4000 times. There are currently over 9000 sections to the Code. Furthermore, the instructions for the original Form 1040 were but one page and now total 174 pages!

Imagine: a brief 100 years has taken personal income tax from an almost unheard of concept in the United States to quite possibly the most common political agenda and debate in our country. In 1913 an amendment had to be passed to confirm the legality of the federal government to collect! Yet, less than 100 years later we lament that the only sure things in life are "death and taxes."

As a tax preparer, I indeed consider these rapid changes and the complicated Code to be job security. Moreover, if ever I doubted the necessity of my work, the Tax Code consistently reaffirms my worth to the public as a tax professional. However, when I became a public accountant I veered to the tax consulting side of our practice because I liked the feeling of being able to help clients. Offering tax planning in this environment of instability is increasingly difficult. Due to the uncertainty and the constant call for tax reform along with, for example, provisions that sunset after a decade and then are up for extension annually: we are forced to offer a shorter term verse long term plan for tax savings.

The concepts that will stand the tests of time are sound financial judgment and living within your means. These can be practiced regardless of the state of tax reform and is the advice I offer most often. Contribute the maximum to your 401K, set up flexible medical savings accounts, consider a 529 College savings plan, be charitable AND consult your financial advisor in conjunction with your tax advisor to consider current year end strategies that will maximize your overall tax and financial position.

Just for fun I have bulleted some facts about our United States personal tax history. Below that I have bulleted some of the most recently released changes that may affect you in 2012.

Just for fun:

• 1861: First personal income tax was imposed to finance the Civil War
• 1862: Bureau of Internal Revenue was created (predecessor of the IRS)
• 1872: The income tax was repealed
• 1913: Sixteenth Amendment was ratified to Constitution granting Congress the power to collect tax on personal income
• 1914: First income tax form (The 1040) was released
• 1915: The lowest tax bracket was taxed at a rate of 1% .The top bracket was 7% on income over $500,000
• 1950 : Tax rate for highest bracket peaked at 92% (for those with incomes greater than $400,000)
• 1952: Income tax peaked in the bottom bracket at 22.2%
• 1981: Largest tax cut in US History
• 1986: President Reagan signed into law the Tax Reform Act of 1986 starting an almost annual tradition of new tax acts.

A sampling of what's new in 2012:

• Personal exemptions increased to $3,800
• Standard deduction increased to $11,900 married filing jointly (MFJ), $5,950 Single and $8,700 head of household
• Tax bracket thresholds also increased for each bracket
• Maximum earned income credit increased to $5,891: Qualifying income limit to $50,270
• Foreign earned income deduction increased to $95,100
• Phase out levels for the lifetime learning credit now start at $104,000 MFJ and $52,000 for single filers
• The phase out for the deduction of student loan interest starts at $125,000 MFJ
• Monthly limit for qualified parking expenses provided by an employer is now $240

Meet our Staff: Andrea Hottleman

As a member of the PRR team for the past three years, our motto Professionalism, Respect and Responsibility is used each time I step into our office or a clients. I focus on auditing our not-for profit, 401K, partnership and corporate clients. The reason I gravitated towards this side of public accounting is because it gives you the opportunity to go to the client and explore their books from balance sheet to income statement. While at the client you are able to work with the owners, management and employees to gain insight into their performance throughout the past year. The client relies on our expertise to help solve issues or uncover issues that may not be seen by the owner, employee or manager who is involved in the day to day operations.

Prior to joining PRR, I spent over 11 years at a medium sized public accounting firm in Boston. Throughout my career, I prepared numerous individual, partnership, not-for profit and corporate tax returns. I also managed audits, review and compilations for HUD and MHFA projects, not-for-profits, partnership, 401K’s and corporate clients. For some of our small business clients, I would consult on business accounting software set up as well as prepare their quarterly payroll tax returns and 1099’s at year end.

My education is from Bentley University in Waltham, MA. I received a Bachelor of Science in Accountancy. Three years after graduation, I decided to go back to Bentley at night in order to obtain my Masters of Science in Taxation.

While away from PRR you may find me volunteering at the schools or at the soccer, football, or softball fields or on basketball courts. If you still have not found me, I may be watching a wrestling match, lacrosse or baseball game or working out at the gym.

PRR is the perfect fit for work and family balance.

Launch a Solo 401(K) Plan by Karla Hopkins

Most limits for retirement plans have not increased in years. However, small business owners can take matters into their own hands and create higher tax deferred deductions by setting up a solo 401(K) plan.

With the usual self employed retirement plans (SEP), the maximum deferral is the lesser of $49,000 or 25% of your net compensation. The maximum compensation that can be taken into account however is $245,000.

In contrast, an employee can make elective deferrals within annual limits and the employer may match part of the employee’s contribution. Therefore, a solo 401(K) plan offers even more.

Under a 401(K) plan, you can elect to defer up to $16,500 annually (or $22,000 if you are over 50). The key to the 401(K) plan is that the elective deferrals don't count towards the 25% cap as described above. So you can combine the employer contribution with an employee deferral for greater savings.

Here's an example. Let's say your wages are $125,000. The maximum SEP you can deduct is $31,250 (25% of your wages). If you had a solo 401(K) plan you could defer $16,500 in addition to the employer match of 25% of your salary ($125,000 x .25) or $31,250 for a total contribution of $47,750 (still below the $49,000 overall limit described above).

For a sole proprietor the 25% is reduced to 20% so that in the example above the total contribution allowed would be $41,500 ($16,500 plus $25,000).

A solo 401(K) plan can also be set up to allow loans and hardship withdrawals in the event you have a casualty. You can also roll over funds from other previous employer plans into your own 401(K) plan. Contributions are discretionary so that if you business is having a bad year, you can skip contributing entirely.

While this is a great tax planning tip, it is not a free ride; there are some downsides to a 401(K) plan. If the business has other employees, they may have to be covered by the plan too. There are moderate costs for running the plan that are generally paid to plan administrators. In the large investment companies like Fidelity, a small plan my be charged a one time setup cost of $100 and annual fees ranging from $50 to $250.

Even with the fees, it is a good option for long term retirement savings, especially if you do not have employees.

Cost Basis Elections and Reporting Requirements by Karla Hopkins

In October 2010, the IRS issued new mandatory regulations regarding the cost basis of stocks. Mutual funds are now required to report cost basis information to the IRS.

Effective January 1, 2012 mutual fund companies will begin their reporting, and to prepare for this they are currently sending investors election forms to dictate how the investor wants the mutual fund company to calculate the cost basis in their shares.

Due to the new regulations, shares in mutual funds will now be broken down into two categories. Shares purchased prior to January 1, 2012 are defined as non-covered shares. Mutual funds are not required to report cost basis to the IRS for shares purchased prior to January 1, 2012. These shares will be costed using the Average Cost Method unless you inform the mutual fund company to use a different method.

Shares acquired after January 1, 2012 are defined as covered shares. Mutual fund companies will now report the cost basis for all covered shares to both you and the IRS. When filing your tax return, YOU ARE REQUIRED TO USE THE
COST BASIS REPORTED ON YOUR 1099-B FOR YOUR COVERED SHARES.

The mutual fund company must select a default method for cost basis reporting and notify you of its selection. These notifications are currently being made by most mutual fund companies. You have the option to choose the same method as the fund's default or you may choose an alternate method. The election is for all future transactions for the mutual fund unless you revoke it.

The different cost methods are: FIFO, a standing order to sell the oldest shares in the account first; LIFO, a standing order to sell the newest shares in the account first; HIFO, a standing order to sell shares purchased at the highest cost first; LOFO, a standing order to sell shares purchased at the lowest cost first; LGUT, a method that evaluates losses and gains then strategically selects lots based on that gain/loss in conjunction with the holding period; SLID, the shareholder designates which specific shares to redeem when placing their redemption request; ACST, a method for valuing cost of covered shares in an account by averaging the effect of all covered transactions in the account.

For many investors, relying on the mutual fund company to provide some sort of cost basis, generally the average cost basis, has been the tax plan. While simplest, this is not always the most strategic, especially when selling high value mutual fund holdings. To keep the calculation in your own hands, the SLID (or specific identification), is the best election to make. Then, when you sell shares, you will notify the mutual fund company of the gain/loss that you expect.

What this change means to most investors is that they should now pay closer attention to their mutual fund purchases, which happen regularly if they reinvest dividends, so that they can identify their potential gains/loss upon future sales. You may also wish to review your cost basis election immediately prior to the sale of investments to determine that it is indeed to be accounted for on the basis that represents optimal tax impact.