Did You Say Accelerate My Income? Part II by Carolyn Flaherty

On May 10^th I published an article on accelerating income. The article discusses some of the provisions that are due to “sunset” as of January 1, 2013 and what their impact will be. As promised, if you anticipate being affected (and there are few people who would not be), here are some suggestions to discuss with your accountant.
Those whose tax rate will increase due to marginal tax rate changes should explore accelerating income to 2012 and/or deferring deductions to 2013. Some ways to do this would be to bill clients earlier, sell appreciated property, avoid installment sales that defer gain, and accelerate bonuses.

Considering charitable contributions? If you are planning to give to charity toward the end of 2012, you may want to defer and contribute in January 2013 when tax rates are higher.

Note also that if tax rates do indeed increase, pre-paying the annual property bills at year end will not be advantageous in 2012.

Furthermore, individuals should review their withholding rate or consider larger estimated tax payments starting in 2013. Married couples and taxpayers with qualifying dependent children should pay particular attention as the child tax credit is slated to revert to $500 per qualifying child and the Marriage Relief Penalty may not be renewed.

If your portfolio includes appreciated capital property, 2012 is a good year to sell. Maximum capital gains rates are slated to jump from 15% to 20% in 2013. As long as the sale is bona fide and the proceeds are received in 2012 you will obtain considerable tax advantage. However, you cannot sell and then immediately after re-acquire without invoking the wash sales rules.
Corporations may want to explore declaring a special dividend before January 1, 2013 to get cash out of the company while it is still taxable to shareholders at the reduced rates. As of January 2013, all dividends will be taxed at the applicable ordinary income tax rates unless legislation is passed.

As advisors, we find it very hard to direct clients during uncertain times such as these. There is always the possibility that some or all of the tax relief provisions will be extended. In which case, the planning and speculation is null and void. Therefore, don’t rush out and sell off your portfolio. However, you should consult your advisor and consider some “what if” scenarios. As year-end approaches, the tax landscape will become clear and if you have a plan in place, you will be able to execute it effectively. Without a plan, you just may end up in a difficult tax situation in 2013.

Did you say Accelerate my Income? PART I: By Carolyn Flaherty

Historically the theme of taxation is defer, defer, defer. After all one in the hand is worth two in the bush so the saying goes. So why might your financial advisors be encouraging you to accelerate income in 2012?

Remember all those Bush-era tax cuts put in place back in 2001 and 2003? The cuts impacted individual, capital gains, and dividend and estate tax rates and made an additional thirty plus tax savings changes to the Tax Code. All those provisions are set to expire at the end of 2012.

The loss of these savings will not only impact the wealthy. On the contrary they impact every single tax payer and quite possible the knockout punch lands more solid on the middle class. Some areas that may affect you:

·         Marginal tax rates are currently 10, 15, 25, 28, 33 and 35 percent. They will increase to 15, 28, 31, 36 and 39.6 percent.

·         While your marginal tax rate inflates your payroll tax is also scheduled to increase 2% as the payroll tax cut enacted under the Middle Class Tax Relief and Job Creation Act of 2012 expires.

·         “Marriage Penalty” relief disappears.

·         Fewer people will qualify for the Earned income Credit.

·         The Child Tax Credit will be reduced from $1000 to $500.

·         Maximum capital gains rates will revert from 15% to 20%.

·         Tax on dividends will go from 15% to the ordinary income rates; or a maximum tax rate of 39.6%.

·         More taxpayers will be subject to the dreaded Alternative Minimum Tax.

·         Coverdell Education Accounts maximum contribution will go from $2000 to $500.

·         The student loan interest deduction will be available to few individuals.

·         Elimination of 100% bonus depreciation, research credit, State and local sales tax deduction, teacher’s classroom expense deduction, mortgage insurance premium deduction, energy tax incentives AND cancellation of mortgage indebtedness exclusion for personal residence.

This is not intended to be and is not an all-inclusive list of the sunset provisions that will impact individuals. Yet, I’m sure each and every person reading this realizes the gravity of the situation. There are also many provisions that will impact businesses that will be discussed in a subsequent blog.

Extending these tax cuts is estimated to cost the government 2.84 million over the next 10 years. To complicate matters, Congress is currently confronted with mandatory reductions in federal spending under the Budget Control Act of 2011. Financially it seems unlikely that government can extend the provisions. However, the impact on individuals will be severe enough that to not extend at least some of the provisions may have dire political impact for the parties. Democrats and Republicans are at a standoff as to how to proceed and agreement before the November elections does not seem likely.

Next week we will explore some ways that you can plan for the sun setting of these provisions and perhaps accelerate some of your income during 2012 to take advantage of the still existing tax breaks before they expire. Tune in for more next Thursday and please comment with any questions you may have about the provisions set to sunset.

Ensuring Alimony Classification by Carolyn Flaherty

Just because a settlement refers to a payment as alimony does not make that payment deductible for income tax purposes. While a payment may indeed be alimony under domestic relations statutes or bankruptcy statutes, it may not be qualified alimony under the Internal Revenue Code. So how do you know the difference?

There are eight requirements, listed below, that ALL must be met in order for a payment to be considered alimony for tax purposes. Each payment is reviewed individually to determine if it meets the criteria to be characterized as alimony. Intent of the parties controls only the property rights of the payment and NOT the classification or deductibility for income tax purposes.

1. Payments must be made under a divorce decree or other written instrument pursuant to such a decree or under a written separation agreement.
2. After divorce or legal separation has been finalized, spouses cannot be members of the same household.
3. Payments must be made in cash or a cash equivalent.
4. The payments must be made to the former spouse or on behalf of the former spouse.
5. The written agreement cannot specifically state that the payments are not alimony.
6. Spouses must file separate income tax returns.
7. The payments cannot be referred to as or deemed to be child support.
8. Payments must terminate upon death of the receiving spouse.

Why does the characterization as alimony matter so much?
The designation effects whether or not the payment is deductible by the payer for federal income tax purposes and includable in income by the recipient. Alimony payments are deductible while child support and other payments are not. Though not commonly utilized, there is an option to elect out of this the alimony classification. In which case the payer agrees not to deduct the payment and the recipient does not include the amounts as income on their return even though the amount qualifies as alimony.

Some common mistakes or stumbling blocks are as follows:

• Any payments that are made before a written agreement is executed are NOT deductible EVEN IF the agreement is made retroactive to the date earlier payments were made.
• Payments made over the amount stipulated in the agreement are NOT deductible. Changes to the amount of alimony must be done via formal modifications of your agreement because an oral agreement is not enough for tax purposes.
• Payments in the form of bonds, annuity contracts, promissory notes, property or services are not deductible.
• Paying the mortgage on a house you own that your former spouse lives in is NOT deductible as alimony. However, if your former spouse owns the home and you pay the mortgage directly to the mortgage company, that payment likely qualifies as a deductible alimony payment.
• Any payments that are automatically reduced upon events related to a child such as a child maintaining a specified age, the death or marriage of a child, completion of child’s schooling, child leaving the household, or a child’s income are deemed child support even if stipulated as alimony by your agreement and are therefore non-deductible.
• When alimony payments stop or drastically reduce within the first three years of your agreement, you may invoke mandatory alimony recapture. Learn more and utilize a recapture calculator at http://www.smartmoney.com/personal-finance/marriage-divorce/deductible-alimony-calculator-9661/

Divorce is messy and confusing emotionally and financially. Properly navigating your settlement agreement and completing your income taxes, particularly in the initial year in which you file separately from your former spouse, will likely require the assistance of a professional. We also recommend that you consult not only an attorney or mediator, but also a tax professional during the preparation of your agreement so that you do not encounter unpleasant and unexpected tax or financial consequences.

Note: Rules as stipulated in this article govern divorce instruments written after January1, 1985. For law prior to that date refer to the prior tax code. Furthermore, the article discusses only federal tax code and does not address state law. Payments qualifying as alimony under federal law do not automatically qualify under state law.

Timing Social Security Benefits by Carolyn Flaherty

Many people wonder when they should begin taking their Social Security benefits. Most people believe that they should wait as long as possible before tapping into Social Security so that payments will be higher. However, choosing when to begin collecting is actually more complex than deferring as long as possible. In reality, timing must be analyzed based on the facts and circumstances of each individual including what other assets the individual has, the taxability of the other assets, what income streams can be generated in retirement and how much income the individual requires.

Although it is estimated that those who begin collecting at age 62 reduce their overall Social Security benefits by 20-30%, in some cases it is actually still more beneficial to begin collecting as early as possible.

For example: the lower income earner in a married couple may wish to begin collecting as early as possible. Why collect early? Because when the higher earner passes away, the lower earner’s benefit level becomes irrelevant anyway and they instead obtain survivor benefits that are essentially an inheritance of the higher income earner's benefits.

This can be particularly true for women who have taken time out of the workforce and therefore have lower total career earnings and hence lower social security benefit levels. Women also generally tend to outlive their male spouses. Therefore, they should consider starting their own benefits as soon as they are eligible.

Taking survivor benefits as early as possible is another scenario where taking early benefits may be financially savvy. Surviving spouses should consider taking survivor benefits while letting their own Social Security benefits continue to grow until age 70, at which point they can switch over to their own benefits.

You can begin collecting Social Security while continuing to work. However, your benefits will be reduced based on the amount your earned income exceeds certain levels established on an annual basis. For example, for the tax year 2012, a person under full retirement age may earn up to $14,640 and NOT lose any benefits. After that threshold your benefits are reduced $1 for every $2 you earn. A beneficiary who is of full retirement age can earn up to $38,880 in 2012 and NOT lose any benefits. After the threshold the benefits are reduced $1 for every $3 earned. Note that these thresholds relate to earned income and not to investment income. For more information visit the frequently asked questions section of the Social Security Administration site at http://ssa-custhelp.ssa.gov/app/home/session/L2F2LzEvdGltZS8xMzM1MzY0Nzc4L3NpZC9qaHhIZHhXaw%3D%3D .

There is no “right” answer that applies to everyone when deciding how to time your Social Security benefits. Therefore, you must do your research and consider consulting an advisor.

Another Season Passes by Carolyn Flaherty (as first posted 4/15/2011)

As the tax season comes to a close, we have decided to recycle this blog which first appeared in April of 2011. We wish you all a lovely spring full of sunshine, hope and happiness...

Most New Englanders can relate to the awaking that public accountants, (particularly those living in New England), experience upon the passing of each tax season. For months we have been entombed in a winter hibernation necessitated by the harsh New England winter and always stalling spring; and for those of us in public accounting, also by our work. Due to shortened days and a heavy workload, for months on end, many of us drive to work in the dark and leave the office in the dark. If we are fortunate enough to have a window in our proximity; we occasionally see the sun.

In New England at least, we can feel comfortable with our pasty pallor and lack of vitamin D. As the deadline approaches we celebrate the rain and cold that clings to our area because it is much easier to concentrate when the outdoors is not calling us to come and play.

Then, the fated day arrives and a feeling like the first day of summer vacation settles upon us all. We are free. We leave the office with a smile instead of a sigh. For the first time in months we are not thinking of the piles of work waiting for us. We are not prioritizing deadlines. We can sleep. We can make plans. We can spend time with our families and savor the moments rather than think of what we “should” be doing. We see the world like someone who has just gotten a pair of glasses and looks in wonderment at the outline of individual leaves on trees rather than the familiar blur of green. All things are brighter and crisper.

We are fortunate that the date often corresponds with April vacation for our youngsters and many of us embark on much needed vacations, in search of sunshine and repose. It is also rather symbolic that as we emerge, the days have begun to lengthen, crocus and tulips are rising from their winter sleep, the Red Sox are back on the field and the world is blossoming all around. Almost as if the world around us is celebrating as well.

I myself find that the energy I have poured into the tax season is now an available resource for the rest of my life and I rapidly throw myself into spring cleaning, landscaping, and a much needed return to physical fitness. As the energy ebbs so does the arrival of summer come upon me and I come in to a routine that matches the flow of the season once again.

Most people would consider a career choice as a public accountant to be a safe and secure career choice with a great deal of potential for advancement and financial gain. All this is true. The career path can also garner a great deal of flexibility. However, I would place a large wager that no college professor or recruiting company ever advises that being a CPA will cause you to appreciate life and routine and simple freedoms the way it does each April 15th.

Are you Due an Unexpected Refund of RI TDI? by Carolyn Flaherty

In March of 2012 a court ruling caused a significant Massachusetts tax law change. Prior to the change, RI Temporary Disability Insurance payments (often referred to as TDI and SDI), were not deductible under a 1977 Letter Ruling. As a result of the change, thousands of employees who reside in Massachusetts but have worked in Rhode Island between the years of 2008 and the current year are eligible for refunds.

How do you I know if I paid TDI? TDI, also reported as SDI, is reported in Box 14 of your Form W2.

The tax is calculated based on the employee’s wages. The TDI payments are placed in a Fund and used by the state to provide relief for the disabled and unemployed. Payments are used to defray the cost of government in Rhode Island by assisting the state in providing income to qualified disabled and unemployed residents. Therefore, the payments are, by definition, a state income tax and are hence eligible as a credit on your home state return.

Retroactive implementation: The refund for RI TDI is available for all open tax years. Therefore, you can apply for a refund for amounts paid all the way back to 2008. However, time is running out. The 2008 tax year closes as of the upcoming filing deadline: for Massachusetts as of April 17, 2012. When that deadline passes 2009 and 2010 tax years remain open for amendment until their statutes run out in upcoming years.

Can I claim the credit on my 2011 Return? Unfortunately you cannot simply claim a credit for previous years on your 2011 return.

How Can I get my money back? If you utilize the services of a professional, they will be able to amend prior year returns for you. The Massachusetts Department of Revenue is suggesting an abatement of tax online at: http://www.mass.gov/dor/forms/electronic-ca-6-notice.html

To file online you will have to set up an account and then follow the steps indicated. Our office has used the online service and found the process easy to follow and quite efficient. You may also file a paper Application for Abatement/Amended Return, Form CA-6 which can be found in the Forms section at www.mass.gov/dor.

How is my refund calculated? The computation of the credit is based on comparing the Massachusetts income tax on income reported to Rhode Island to the actual tax plus TDI paid to Rhode Island; the credit is limited to the smaller of these two amounts. To recalculate the credit, the TDI should be included as part of the total tax paid to Rhode Island.

Rhode Island employees residing in Massachusetts are the most likely beneficiaries of this law change. However, other states that have similar disability insurance funds include NewYork, New Jersey, Illinois, California, Hawaii and Puerto Rico. Therefore, Massachusetts residents that have worked in any of these states may also be affected and should review their tax returns.

Eight Things to Know about Medical and Dental Expenses and Your Taxes IRS Tax Tip 2012-30

If you, your spouse or dependents had significant medical or dental costs in 2011, you may be able to deduct those expenses when you file your tax return. Here are eight things the IRS wants you to know about medical and dental expenses and other benefits.

1. You must itemize You deduct qualifying medical and dental expenses if you itemize on Form 1040, Schedule A.

2. Deduction is limited You can deduct total medical care expenses that exceed 7.5 percent of your adjusted gross income for the year. You figure this on Form 1040, Schedule A.

3. Expenses must have been paid in 2011 You can include the medical and dental expenses you paid during the year, regardless of when the services were provided. You’ll need to have good receipts or records to substantiate your expenses.

4. You can’t deduct reimbursed expenses Your total medical expenses for the year must be reduced by any reimbursement. Normally, it makes no difference if you receive the reimbursement or if it is paid directly to the doctor or hospital.

5. Whose expenses qualify You may include qualified medical expenses you pay for yourself, your spouse and your dependents. Some exceptions and special rules apply to divorced or separated parents, taxpayers with a multiple support agreement or those with a qualifying relative who is not your child.

6. Types of expenses that qualify You can deduct expenses primarily paid for the diagnosis, cure, mitigation, treatment or prevention of disease, or treatment affecting any structure or function of the body. For drugs, you can only deduct prescription medication and insulin. You can also include premiums for medical, dental and some long-term care insurance in your expenses. Starting in 2011, you can also include lactation supplies.

7. Transportation costs may qualify You may deduct transportation costs primarily for and essential to medical care that qualify as medical expenses. You can deduct the actual fare for a taxi, bus, train, plane or ambulance as well as tolls and parking fees. If you use your car for medical transportation, you can deduct actual out-of-pocket expenses such as gas and oil, or you can deduct the standard mileage rate for medical expenses, which is 19 cents per mile for 2011.

8. Tax-favored saving for medical expenses Distributions from Health Savings Accounts and withdrawals from Flexible Spending Arrangements may be tax free if used to pay qualified medical expenses including prescription medication and insulin.

For additional information, see Publication 502, Medical and Dental Expenses or Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans, available at www.irs.gov or by calling 800-TAX-FORM (800-829-3676).

Links:
•Publication 502, Medical and Dental Expenses (PDF)
•Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans (PDF)