Congressional Research Service Examines Expiring Tax Provisions

A new Congressional Research Service (CRS) report examines the tax provisions currently set to expire at the end of the year and the budgetary costs and policy considerations associated with extending them. These include the so-called Bush tax cuts, the alternative minimum tax (AMT) patch, the payroll tax cut, and a host of other miscellaneous provisions and “tax extenders.”

Each category of expiring provisions, including 2012 law, currently scheduled changes if the provisions aren’t extended, and relevant budgetary and policy considerations, is addressed separately.

The Bush Tax Cuts. The Bush tax cuts were primarily enacted by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA, P.L. 107-16) and the Jobs Growth Tax Relief Reconciliation Act of 2003 (JGTRRA, P.L. 108-27) under President Bush. The Bush tax cuts, as referred to in this article, also include several modifications and additions made by the American Recovery and Reinvestment Act of 2009 (ARRA, P.L. 111-5). The Bush tax cuts were extended through 2012 by President Obama as part of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Tax Relief Act, P.L. 111-312).

Current law. The Bush tax cuts currently set to expire at the end of 2012 include:

• reduced individual tax rates (10%, 15%, 25%, 28%, 33% and 35%);
• reduced long-term capital gain rates (maximum 15%);
• reduced qualified dividends rate (15%);
• no phase-out for personal exemptions (the personal exemption phaseout, or “pep,” limitation);
• no phase-out for itemized deductions (the “Pease” limitation);
• expanded tax credits, including the earned income tax credit (EITC), child tax credit (CTC), adoption credit, and dependent care tax credit;
• reduced marriage penalty (i.e., increased standard deduction and upper limit of the 15% bracket for married taxpayers to 200% of that for singles, and increased income level at which the EITC begins to phase out);
• modified education tax incentives (including Coverdell education saving accounts (ESAs), the student loan interest deduction, favorable tax treatment of certain scholarships and fellowships, and an exclusion for employer-provided educational assistance).

The Bush tax cuts also gradually reduced the estate tax over 2002 to 2009, leading to its repeal in 2010. The 2010 Tax Relief Act reinstated the estate tax for 2010  and enacted a $5 million exemption (adjusted for inflation in 2012), a top tax rate of 35%, and a step-up in basis through 2012. The 2010 Tax Relief Act also introduced the new “portability” feature allowing a deceased spouse’s unused exemption to be shifted to the surviving spouse.

Post-2012 scheduled changes. If the above provisions are allowed to expire, for tax years beginning after Dec. 31, 2012:

• individual income tax rates will rise to 15%, 28%, 31%, 36% and 39.6%;
• long-term capital gains will be taxed at a maximum rate of 20%;
• dividends will be taxed as ordinary income;
• the limit on personal exemptions will be restored such that, for higher-income taxpayers, the total amount of exemptions that can be claimed will be reduced by 2% for each $2,500 by which the taxpayer’s adjusted gross income (AGI) exceeds a certain inflation-adjusted threshold;
• the limit on itemized deductions will be restored such that, for higher-income taxpayers, the total amount of itemized deductions will be reduced by 3% of the amount by which the taxpayer’s AGI exceeds a certain inflation-adjusted threshold;
• the CTC, adoption credit, and dependent care tax credit will all be cut back;
• the standard deduction and upper limit of the 15% bracket for married couples will fall from 200% to 167% of the deduction and upper limit for unmarried taxpayers, and married taxpayers will be subject to the same EITC phase-out levels as unmarried taxpayers; and
• the education incentives will disappear altogether or be significantly cut back.

Additionally, after 2012, the estate tax exemption is scheduled to fall to $1 million, and the top rate will revert to 55%.

Budgetary effects.  The budgetary cost of the 2010 Tax Relief Act’s two-year extension of the Bush tax cuts was a $475.79 billion revenue reduction over a 10-year window (2011-2020). Of this, $363.55 billion is from the extension of income tax provisions, and $68.15 billion is from the estate tax provisions. The Congressional Budget Office (CBO) estimated that further extending the income and estate tax provisions through 2022 would cost $2.84 trillion over the 2013-2022 period.

Policy considerations. Proponents of the Bush tax cuts argue that lower tax rates boost economic growth, and that allowing them to expire in 2013 may negatively impact the economy.

Opponents of the cuts note that the cuts overall reduced the progressivity of income taxes and disproportionately benefitted high-income taxpayers. According to CBO estimates, approximately two-thirds of the benefits of the cuts went to the top 20% of taxpayers with the highest income, and 26.5% of the benefits accrued to the top 1%. The CRS report observes that the distribution impact “may be relevant to policy makers if they are concerned with growing income inequality in the United States.” However, the report noted that the expansions of the CTC and EITC reduced income inequality.

AMT rules. The AMT was enacted to ensure that higher-income taxpayers who would otherwise be able to pay little or no taxes will pay a “minimum” amount. In calculating the AMT, taxpayers add back various tax preference items to their taxable income to calculate their AMT tax base, claim a basic exemption amount therefrom, then apply either a 26% or 28% rate. The extent to which this figure exceeds a taxpayer’s regular tax liability is his AMT.

Certain parts of the AMT, however, were not indexed for inflation. To deal with this issue, the AMT exemption amount has been increased several times on a temporary basis (part of the “AMT patch”). The 2011 AMT patch allowed married individuals filing jointly and unmarried individuals exemptions of $74,450 and $48,450, respectively. The AMT patch also generally includes a provision allowing taxpayers to reduce their AMT by nonrefundable personal tax credits.

Current law. For 2012, absent another patch, the AMT exemption amounts are $45,000 for married individuals and $33,750 for unmarried individuals, and most nonrefundable credits won’t be allowed against the AMT. A separate CRS report estimates that, unless Congress acts, 30 million plus taxpayers, or roughly one-fifth of all taxpayers, could be hit by the AMT in 2012.

Although we’re well into 2012, AMT patches are often passed later in the year. For example, the AMT patch for 2010 wasn’t enacted until Dec. 17, 2010, as part of the 2010 Tax Relief Act.

Budgetary effects.  The Joint Committee on Taxation (JCT) estimates that a one-year AMT patch for 2012 would reduce revenues by $92 million over the 2012-2021 period. For later years, the cost of the AMT patch depends on the regular tax rates since the AMT is calculated in reference to them. If the Bush tax cuts are allowed to expire, the cost of indexing the AMT to inflation through 2022 is estimated to be $804 billion over the 2013-2022 period.

Policy considerations.  As a result of the lack of certain AMT inflation adjustments, taxpayers who aren’t necessarily the higher-income targets of the AMT may nonetheless be subject to it. The dueling aims of the AMT debate are not subjecting these unintended taxpayers to the AMT, while at the same time minimizing losses in federal revenue that would result from another AMT patch.

The CRS report states that Congress may “consider indexing the AMT for inflation” or “reform the regular income tax system in such a way that the AMT no longer exists.”

To help stimulate the economy by increasing workers’ take-home pay, the 2010 Tax Relief Act reduced by two percentage points the employee OASDI tax rate under the FICA (from 6.2% to 4.2%) and the OASDI tax rate under the SECA tax for the self-employed (from 12.4% to 10.4%) on the first $106,800 of wages. The temporary reduction was originally scheduled to expire at the end of 2011.

Current law. The 2-point reduction was ultimately extended through 2012 by the Middle Class Tax Relief and Job Creation Act of 2012 (P.L. 112-96). Thus, for the first $110,100 of remuneration received during 2012, the 4.2% and 10.4% rates apply.

Post-2012 scheduled changes.Absent Congressional action, the OASDI rates will revert to normal levels.

Budgetary effects.The cost of the payroll tax cut for 2011 and 2012 is estimated at $225.7 billion for the 2011-2022 period.

Policy considerations.Although the payroll tax cut benefits most taxpayers, research shows that it “may not be as targeted or cost-effective a stimulus as other tax policies or direct-spending programs” Since it is based on the amount of wages received by a taxpayer, the actual value of the tax cut depends on the taxpayers wages-thus providing a smaller benefit to lower earners. Additionally, since many of those who receive a benefit from the payroll tax cut aren’t necessarily facing fiscal constraints, some of the funds may be saved instead of spent, reducing the cut’s stimulative effect.

According to the CBO, although the short-term stimulus impact of the payroll tax cut is lower than if aid were increased to the unemployed, or if additional refundable tax credits were provided to low and middle income households, the payroll tax cut was nonetheless more stimulative in the short term than extending the Bush tax cuts.

Miscellaneous expiring provisions and “tax extenders.”A number of temporary tax provisions have either expired at the end of 2011 or are scheduled to expire at the end of 2012. These provisions generally relate to individuals, businesses, charitable giving, energy, community development, or disaster relief. Many of these provisions were originally enacted with expiration dates that have been routinely extended on a short-term basis (hence the term “tax extenders”), but there are also several expiring provisions that have not been previously extended. Tax extenders are often considered as a group during the enactment process.

Budgetary effects. The cost of extending temporary provisions depends on which provisions are extended and for how long. Following are several significant individual and business provisions that expired after 2011, and the 10-year cost of a one-year extension:

• the deduction for state and local sales taxes under Code Sec. 164(b)(5) ($2.79 billion);
• the above-the-line deduction for qualified tuition and related expenses under Code Sec. 222(e) ($780 million); and
• the treatment of mortgage insurance premiums as deductible qualified interest under Code Sec. 163(h)(3) ($740 million).

Expired business provisions include, among others:

• the Code Sec. 41(h)(1)(B) research credit ($7.65 billion);
• 100% bonus first-year depreciation under Code Sec. 168(k)(5) ($5.97 billion);
• 15-year straight-line cost recovery for qualified leasehold, restaurant, and retail improvements under Code Sec. 168(e) ($2.93 billion); and
• the Code Sec. 51(c)(4) work opportunity tax credit ($970 million).

The CRS report provides a thorough list of the expiring provisions in each category (individuals, businesses, charitable giving, energy, community development, and disaster relief), as well as the associated extension costs where available.

Policy considerations.The CRS report opines that there are several reasons that Congress enacts tax provisions on a temporary basis-to provide short-term stimulus, to provide short-term disaster relief, or to encourage routine evaluation of whether a provision is effective. Additionally, the budgetary cost of short-term extension is less. However, the temporary nature of these provisions, and the accompanying uncertainty about how long they will be around, limits their effectiveness in achieving policy objectives.

In testimony before the Senate Committee on Finance, an economics professor queried whether temporary tax legislation is a mere “budget game,” since CBO’s estimates are made on the basis of current law (thus assuming that “temporary” provisions expire as scheduled, even if that is extremely unlikely).

Payroll Tax Cut.  The Federal Insurance Contributions Act (FICA) imposes two taxes on employers, employees, and self-employed workers-one for Old Age, Survivors and Disability Insurance (OASDI; commonly known as the Social Security tax), and the other for Hospital Insurance (HI; commonly known as the Medicare tax).

If you have any questions regarding these tax developments, please contact your Warren Averett Wilson Price Division accountant.

Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

Tax Saving Strategies for Your 2011 Form 1040

There is no better source for saving taxes than your AICPA member accountant.  Here is what the AICPA recommends that will not only help you complete your tax return, but may also help you minimize your 2011 tax bill.

Whether you’re training for a marathon, landing the job of your dreams or closing a sale, you’re not going to succeed without being well prepared and fully informed.  The same holds true when managing and preparing your taxes.

Waiting until the return due date of April 17th for the 2012 filing season to put your financial house in order is a straight path to paying higher taxes. To manage your taxes and minimize your tax bill, you need to know the rules of the game, which are constantly changing, and you want to take advantage of year-round tax-planning opportunities.

The Basics

An understanding of the tax-return filing process can make tax season a more positive experience, so we’ll begin by taking a quick look at a few of the basics, beginning with the standard deduction.

Standard Deduction

The standard deduction is the basic deduction all taxpayers can take.  Every year, the IRS adjusts the standard deduction to account for inflation. For 2011, the standard deduction is $5,800 if single or married filing separately and $11,600 if married filing jointly or qualifying widow(er)s. It’s $8,500 if head of household.  Taxpayers age 65 and older or taxpayers who are blind receive an additional standard deduction of $1,450 (single or head of household) or $1,150 (married filing jointly, married filing separately or qualifying widow/er).

Itemizing Deductions

An alternative to claiming the standard deduction is itemizing your deductions. To determine the best strategy, total all of your deductions. In general, if your total allowable itemized deductions are more than the standard deduction, then you should probably itemize, although there are exceptions. Itemized deductions include medical expenses, certain state and local taxes, sales taxes (in lieu of income taxes), mortgage interest, charitable contributions, casualty and theft losses, and other miscellaneous items such as tax-return preparation fees, investment advisory fees and unreimbursed employee business expenses. Tables for the sales tax deduction are provided in the IRS instructions.

In years past, high income taxpayers were required to reduce their itemized deductions by means of a “phaseout”.  There is no phaseout of itemized deductions for 2011.

If you find you’re getting close to exceeding the standard deduction limit, try bunching your tax breaks every other year. This allows you to claim the standard deduction one year and itemize the next, but it also allows you to plan for the maximum tax benefit.

Also, since itemized deductions are a factor in determining if you’re subject to the AMT, which we will be discussing in detail, some pre-planning might help if you’re in this situation.

Charitable Deductions

Making charitable contributions can instill a feeling of goodwill and tax laws have been created to recognize philanthropic efforts.

Donations you make by cash, check or credit card to qualified religious, charitable, educational or other philanthropic institutions are deductible up to 50% of your AGI, if you itemize your deductions. Contributions that are not deductible include those made to political groups, fraternities and sororities, certain scholarships, for-profit hospitals, and blood banks.  In general, if your cash donations exceed 50% of your income, you can carry them forward for up to five years.

Also, remember to obtain and keep a record to substantiate all donations, regardless of the amount, even cash donated to charitable organizations such as the Salvation Army’s Red Kettle drive during the holidays and when attending religious services. Substantiating documents range from a cancelled check and credit-card statement to a W-2 form and a written statement from the organization. The type and extent of documentation is usually determined by the amount of the donation.

Your charitable donations of more than $75 require a disclosure statement from the organization stating the value of any received benefit. Also, you can only deduct a charitable donation of $250 or more if you have a statement from the charitable organization showing the amount of money contributed, and a description, but not value, of any property donated and whether the organization did or did not provide you with any goods or services in return for the contribution.

Donating appreciated assets that qualify for the long-term capital gains treatment can actually do more to cut your tax bill. However, in most cases these donations are limited to 30% of income, with excess amounts carried forward for up to five years. When you give appreciated long-term securities to a nonprofit, you deduct the full market value of the asset at the time of the donation and you avoid paying capital gains tax on the appreciation. Be sure to follow substantiation and other requirements.

A tax deduction for clothing and household items is generally allowed only if the items are in good condition. Automobiles may be contributed to a charity, but the amount of the deduction may depend on what the charity does with the vehicle. These types of donations, as with other donations of tangible property, are included with your cash contributions to determine your annual limit. A single item with a value greater than $500 is subject to special substantiation rules.

Alternative Minimum Tax (AMT)

In addition to the regular income tax, more and more taxpayers are subject to the AMT.

The AMT applies to both higher-income taxpayers as well as to lower-income taxpayers with a large number of exemptions or other tax adjustments. Since the AMT is not indexed for inflation, taxpayers are increasingly finding themselves affected by the AMT.

Some items that can trigger the AMT include:

• A higher-than-average number of dependency exemptions
• Large deductions for state and local income taxes
• High real estate taxes
• Miscellaneous itemized deductions and medical expenses

Congress has attempted to limit the impact of the AMT by increasing the amount of exempt income.

For 2011, the AMT exemption amounts are $48,450 for single filers and $74,450 for married taxpayers filing jointly. However, the exemption amount begins to phase out when AMT income exceeds $112,500 if single or $150,000 if married filing jointly. Exemption amounts may decrease in 2012.Unfortunately, the AMT defies most traditional tax-planning strategies. If you’ve been close to the threshold, you’ll need to consult with your CPA for specific advice on how the AMT may affect you this tax season.

TAX STRATEGIES & INCENTIVES

Now that we have the basics behind us, it’s time to move further ahead.   Let’s consider six categories that every taxpayer can relate to:

• Family
• Education
• Job
• Home
• Investments
• Retirement

FAMILY

Let’s start with some tax breaks for which you may be eligible if you are raising a family. If you’re a parent, you want to be sure to take advantage of every tax-saving opportunity available. In this section, we’ll discuss:

• Kiddie Tax
• Child Tax Credit
• Adoption Credit
• Health Savings Accounts
• Health Flexible Spending Arrangements
• Dependent Care Tax Credit
• Long-term Care Premium
• Shifting Income

A credit is the best tax break you can get. Deductions reduce the amount of taxable income on which you must pay taxes, but tax credits reduce, dollar-for-dollar, the taxes you actually owe.

Kiddie Tax

A tax strategy long employed by parents was to shift assets to a child’s name with the result that the investment income would be taxed at the child’s lower tax bracket. However, recent changes make this strategy less beneficial.

To discourage income splitting of investment income between parents and minor children, the tax law has imposed a Kiddie Tax under which any investment income over $1,900 will be taxed at the parent’s tax rate. If a child has unearned income of $1,900 or less, the tax is computed based on the child’s regular tax liability. Thus, the first $950 of unearned income would not be taxed – that is the standard deduction amount for a child. The next $950 of unearned income would be taxed at the child’s tax rate. Even if the Kiddie Tax does apply, regular tax liability must be computed, with the child paying the higher tax liability.

The tax does not apply if both of a child’s parents were deceased at the end of 2011 and regular rules are followed to determine the child’s tax.

The Kiddie Tax applies to investment income of children in these three categories: (1) children under age 18 at the end of 2011, (2) children who are age 18 at the end of 2011 and do not have earned income exceeding 50% of their support for the year and (3) children age 19 through 23 at end of 2011 and who are full-time students and who do not have earned income exceeding 50% of their support for the year. The tax also applies if the child is married and files separately.

Child Tax Credit

The Tax Relief, Unemployment Insurance Reauthorization and Jobs Creation Act of 2010 extended the Child Tax Credit to tax years 2011 and 2012.  The credit is worth $1,000 for each qualifying child who is under age 17 at the end of the calendar year and who qualifies as a dependent – your son, daughter, adopted child who lived with you all year, stepchild or eligible foster child, brother, sister, stepbrother, stepsister, or a descendant of any of these individuals. The child must also be a U.S. citizen, resident or national. The Child Tax Credit is in addition to the child’s dependency exemption.  That means if you have three children, the child credit can potentially reduce your tax bill by $3,000.

Adoption Credit

There is good news for people who are planning to adopt a child under age 18 or a person incapable of self-care due to physical or mental challenges because there are two tax benefits that offset escalating adoption expenses.

In 2011, the adoption credit, which is fully refundable, rose to a maximum of $13,360 per child. Parents who work for companies with an Adoption Assistance Program can receive up to a $13,360 reimbursement from their employer for qualified adoption expenses without paying taxes on that benefit.

When adopting a child who is a United States citizen or resident, the family is permitted to take the credit in the year following the year when the actual expense was incurred. These expenses may be taken as a credit even if the adoption ultimately is not completed. Where a foreign adoption is involved, the family may not deduct any expenses, regardless of the year incurred, until the adoption is final.

When you adopt a child with special needs, you are allowed to claim the full credit regardless of actual expenses paid.

Health Savings Accounts

Health Savings Accounts (HSAs) are designed for individuals covered by a High Deductible Health Plan (HDHP) and are not covered by Medicare. HSAs offer a wide range of tax advantages: contributions within certain limits are tax deductible and earnings that accumulate within the account are not taxed until withdrawn, and even under those circumstances, withdrawals to pay for qualified medical expenses are tax free. However, withdrawals you may make for medical expenses that are not qualified are both taxable and subject to a 20% penalty unless you are age 65 or older or disabled.

Health Flexible Spending Arrangements

Although employees are increasingly responsible for some or all of their medical expenses, many companies are offering Flexible Spending Arrangements (FSAs) to help employees pay for these expenses. Employees can contribute some of their wages to these special accounts and the amounts are not taxed in 2011. Funds can be accessed any time during the year to pay for health insurance premiums as well as medical costs and other expenses not covered by insurance, although they must qualify as a deductible medical expense. Reimbursable medical expenses include prescription medications such as over-the-counter drugs prescribed by your doctor. Beginning in 2011, the cost of non-prescription drugs other than insulin can no longer be reimbursed by an FSA. The company’s plan determines contribution terms and limits. It is important to remember that funds not used during the year, or by the end of any grace period the plan may offer, are lost.

Dependent Care Tax Credit

Working parents know how expensive child care can be. The Dependent Care Tax Credit aims to ease some of the burden. Basically, the credit works like this: If you pay someone to care for a dependent under age 13, you may be eligible for a tax credit of up to $2,100. The credit is a percentage of qualifying expenses that range from 20% to 35%, depending on your AGI. You must have earned income to receive the credit and if married, file a joint return.

The dollar limit on the expenses toward which you can apply the credit percentage is $3,000 for the care of one qualified dependent and $6,000 for the care of two or more. Thus, the maximum credit allowed in 2011 is $1,050 if you have one qualified dependent and $2,100 if you have two or more qualified dependents.

Taxpayers should note that the dependent care credit is reduced by the value of qualifying day care provided by your employer under a written, non-discriminatory plan, which generally is not taxable up to $5,000 ($2,500 if married filing separately).

This credit is not restricted to child-related care costs. If you pay someone to look after an incapacitated spouse or dependent of any age, such as a parent or disabled family member, you may also be eligible for this tax break.

Long-term Care Premium

An increasing number of Americans require long-term care due to advanced age or chronic conditions. Unfortunately, nursing homes and their high costs, which can exceed $70,000 annually, are not covered by Medicare or supplemental Medicare insurance. However, long-term care insurance pays for this type of care and a portion of your premiums, based on your age, is tax deductible as a qualified medical expense. The deductible increased in 2011.

You can include your premiums for qualified long-term care services as medical expenses up to the following amounts:

• Age 40 or under - $340
• Age 41 to 50 – $640
• Age 51 to 60 - $1,270
• Age 61 to 70 - $3,390
• Age 71 or over – $4,240

Shifting Income

Investment strategies have to be right for you and appropriate for the economic environment. The current economy makes some of the following strategies more or less beneficial, depending on your circumstances. Income tax rates may increase after 2012, although there is also some movement to see the rates decreased. Regardless of what may ultimately happen, you need to be prepared to react to any change so I recommend that you first check with your CPA financial advisor on these matters.

Kiddie Tax

Let’s begin with strategies for how parents can save on taxes.  As we discussed earlier, shifting income to a child in a lower tax bracket can be a smart strategy and may provide the Kiddie Tax with a place in your overall tax plan. However, as I mentioned, it won’t pay to shift a significant amount of income to a child falling under the Kiddie Tax rules, but transferring a few income-producing assets to a child might still lower your overall tax bill.

Gift Tax

Be sure to also consider the gift tax when shifting assets. For 2011, you generally can give a gift to a child, or anyone else, valued at up to $13,000 each without being subject to the gift tax. It rises to $26,000 if your spouse agrees to split the gifts. The exclusion is allowed only for cash gifts or present interests in property.

Family Business

If you’re a sole proprietor, you can shift income by hiring your minor children to help in your business. In addition to providing valuable work experience for your child, this arrangement can offer tax savings to the business. As long as the work your children do is legitimate, you follow all the rules and your children receive reasonable wages, you can deduct their wages as a business expense and shift the money to your children in lower tax brackets. And as an added bonus, if your son or daughter is under age 18, you don’t have to pay Social Security or Medicare taxes on the wages you pay.  Also, since their wages are earned income, they are not subject to the Kiddie Tax.

EDUCATION

Education Strategies

Since in most cases education accounts for the greatest cost associated with raising kids, you’ll want to read carefully to learn all you can about the credits and deductions for education expenses. Keep in mind that these benefits are available to college students of every age.

Tax Credits

Two popular tax credits – the American Opportunity Tax Credit and the Lifetime Learning Credit – can help defray education expenses for you and your children. And because they are credits rather than deductions, they take a bigger bite out of your tax bill.However, you cannot claim both credits for the same student’s expenses in the same tax year so you’ll need to decide which credit delivers the greater tax savings.

American Opportunity Tax Credit

For 2011 and 2012, the American Opportunity Tax Credit, previously known as the Hope Scholarship Credit, is available to each eligible student and for the first four years of college or other postsecondary school that leads to a degree, certificate or other recognized educational credential. It does not apply to graduate-level courses.

The maximum credit is $2,500 per student for each year and 40% of the credit is refundable, meaning it can reduce your liability below zero and you can receive up to $1,000 even if you owe no taxes.The credit applies to 100% of the first $2,000 of costs and 25% of the next $2,000 of costs. This means you must spend at least $4,000 to obtain the maximum credit of $2,500.  Costs include tuition as well as student-activity fees required for enrollment and attendance. They also include books, supplies and equipment needed for a course of study that must be purchased from the educational institution as a condition of enrollment or attendance. This credit is allowed against the AMT.

Lifetime Learning Credit

The Lifetime Learning Credit provides a credit of up to $2,000 per year. It applies so long as the American Opportunity Tax Credit is not also being claimed for the same student and can be claimed for every year that you qualify to receive it. As its name suggests, the Lifetime Learning Credit can be used by you, your spouse or your dependent(s) for undergraduate, graduate and professional-degree expenses at an eligible educational institution – tuition as well as student-activity fees required for enrollment and attendance. It also applies to books, supplies and equipment needed for a course of study that must be purchased from the educational institution as a condition of enrollment or attendance. Unlike the American Opportunity Tax Credit that applies to each student, the Lifetime Learning Credit applies to each taxpayer and courses taken do not need to be toward a recognized educational credential.

Student Loan Deduction

If you’re paying off student loans, you’ll be happy to know that the rules for deducting student loan interest remain liberal. Taxpayers can continue to deduct up to $2,500 of the interest paid on a qualified student loan as an adjustment to gross income, regardless of how long it takes to repay the loan. And you don’t have to itemize in order to take this deduction. However, there is no deduction if you file as married filing separately, you are claimed as a dependent or the loan is from a related party or a qualified employer plan.Similar to many other provisions, the deduction is limited for certain income amounts.

Higher Education Tuition and Fees Deduction

In 2011, you can claim a tuition and fees deduction – up to $2,000 or $4,000 – as an adjustment to gross income for qualified expenses that you paid for higher education at an eligible educational institution. This deduction, which is available each year you qualify for it, generally applies to the same expenses as those covered by the American Opportunity Tax Credit and Lifetime Learning Credit. The deduction applies to you, your spouse and any dependents who you claim as an exemption. The deduction is barred if your filing status is married filing separately, you can be claimed as a dependent, or if you claimed the American Opportunity Tax Credit or Lifetime Learning Credit.  Similar to many other provisions, there are limits for certain income thresholds.

Qualified Tuition Programs (529 Plans)

Qualified Tuition Programs, also known as 529 Plans, give parents and other family members a tax-advantaged way to save money for college expenses. While there is no tax deduction or credit available on contributions to the plan, the money in the plan grows tax free and no tax is due on withdrawals if the distribution is used to pay for qualified higher-education expenses. There may also be state income tax breaks for plan contributors. Expenses include tuition, room and board, books, supplies, and fees. There is no dollar limit for these expenses. Unlike 2010, computers and other technology equipment and services are no longer qualified expenses.

529 Plans are often used as vehicles for gifts from family members, especially grandparents.

Prepaid Tuition Plans

When saving for tuition, you are not restricted to using your state’s savings plans and can use any state’s plan. The Internet is an invaluable research tool. However, if you select another state’s plan, you may lose a state tax deduction that some states offer to residents who use their state’s prepaid or 529 Plans. Many states have instituted savings plans substantially similar to 529 Plans that propose to create a prepaid tuition account for a student in that state. The amount contributed will depend on when the plan is begun and the child’s age. States have created actuarial tables that they believe will result in a fully funded tuition based on a schedule of deposits and investment-return rates.The advantage of these plans is that they guarantee tuition costs will be covered. However, they do not guarantee admissions, and they do not cover room and board and the cost of books. These expenses would have to be funded separately. The plans provide assistance if the student decides not to attend an in-state school; however, it may not cover the full tuition costs of these schools.In general, the tax treatment of these prepaid tuition plans is similar to 529 Plan rules.

U.S. Savings Bonds

Generally, investors who redeem U.S. savings bonds to pay for qualified higher education expenses may exclude the interest redeemed from gross income. The exclusion has no dollar limit and it applies to Series EE bonds issued after 1989 or Series I bonds.

JOB

Job Search Tax Benefit

For many of us, we spend the majority of our day on the job and the hours we typically devote to our work seem to grow even greater during rocky economic times. However, in addition to a paycheck, experience and hopefully some degree of satisfaction, we receive a number of benefits that have important tax implications, one of which pertains to our job search efforts.  Many unreimbursed expenses incurred as a result of employment are deductible as miscellaneous itemized deductions, though they can only be claimed to the extent they are greater than 2% of adjusted gross income. Included among these expenses are job search costs. These expenses are deductible if the search is for a job in the same line of work, regardless of whether a new position is obtained. However, if a period of unemployment is lengthy, the IRS may disallow the deduction. Also, expenses for finding a first job are not deductible.

HOME

Homeowner Strategies

Now let’s turn our attention to the tax benefits of owning a home, because as a homeowner there are many tax-saving opportunities available to you.

Deductions

Mortgage Interest

In most cases, you can deduct all of the interest you pay on any loan secured by your home if you itemize your deductions. Interest is generally deductible on up to $1 million ($500,000 if married filing separately) of home-acquisition loans. These are loans used to buy, build or substantially improve your principal residence or second home, and are secured by that same residence. Interest on a home-equity loan up to $100,000 ($50,000 if married filing separately) is also deductible. You can also use this deduction for one additional residence that you identify as your second home.This means you can deduct interest on total home debt up to $1.1 million ($550,000 if married filing separately).

As long as the home-equity loan is secured by your home, it doesn’t matter how you spend the proceeds. Home improvements, college tuition, debt consolidation or an exotic vacation – it’s up to you. Just be sure you have a plan to pay it back.

The IRS defines points as any extra charges paid by a home buyer at closing in order to obtain a mortgage. In effect, points are prepaid interest. Points paid to secure a loan for the purchase, construction or improvement of a principal residence are usually fully deductible in the year you paid them. Points paid to buy or improve a second home must be deducted ratably over the term of the loan.

Real Estate Taxes

After the home-mortgage interest deduction, the next most important tax break for homeowners is the deduction for real estate taxes. You can deduct as an itemized deduction real estate taxes and state and local property taxes on all the real estate you own. There are no limits on the dollar amount of real estate taxes you can deduct or on the number of homes for which you can claim the deduction. The only decision you may need to make is whether you prepay the coming year’s taxes or delay the current year’s taxes to see which way it might benefit you.

Selling Your Home

Excluding the gain on the sale of a home is another major incentive for buying a home. If you meet certain requirements, you can keep a significant portion of the profit of the sale of your principal residence without having to pay tax on the gain. Any gain is taxed as a capital gain so the amount owed is not as high. However, any losses on the sale of a principal residence are not deductible.

When you sell your principal residence, you can exclude from income up to $250,000 in gains ($500,000 if married filing jointly or a surviving spouse if the sale is within two years of the other spouse’s death). If you realize a gain on the sale greater than the exclusion, that amount is taxed at capital-gains rates.

To qualify, you must have owned and used your home as a principal residence for at least an aggregate of two of the five years preceding the sale.

The exclusion is available even if you took temporary absences, including vacations, or rented out the home while not living there.

Special rules are provided for sales of the home due to certain health issues, employment reasons or unforeseen circumstances, and for members of the uniformed services.

Keep in mind that if you took a First-time Homebuyer Credit, you may have to repay or recapture some or all of the loan/credit in 2011. Also, if you used your residence as a home office, you may need to make other adjustments.

First-time Homebuyer Credit

The First-time Homebuyer Credit does not apply to home purchases made in 2011 unless the taxpayer or his or her spouse is a specific public employee on extended official duty outside the United States. The credit for other homebuyers ended with purchases completed by or in contract on April 30, 2010.

However, if you claimed the 2008 credit for a home you purchased after April 8, 2008 and before January 1, 2009, in most cases the credit must be repaid, though interest free, over 15 years in 15 equal installments. For all taxpayers, no matter the year claimed, if you sold or otherwise disposed of the home, or used it differently in 2011, you generally are required to repay the complete credit when you file your 2011 tax return.

Home Energy Incentives

In 2011, homeowners can again claim tax credits for making certain energy-saving improvements to their home. These credits include the (1) Nonbusiness Energy Property Credit and (2) Residential Energy Efficient Property Credit. However, the credits are not as favorable as 2010.Under the Nonbusiness Energy Property Credit, homeowners can receive a credit of 10% of the costs of qualified energy-efficient improvements and 100% of the costs of certain energy property expenditures, although dollar limitations may apply to specific types of property, including a maximum lifetime credit of $500. Energy efficient improvements include insulated walls or ceilings; energy-efficient exterior doors and windows, including skylights; specially treated metal or asphalt roofs; and a high-efficiency furnace, water heater or central air conditioning system, and energy property expenditures such as certain heat pumps, water pumps and circulating fans.

The 30% Residential Energy Efficient Property Credit applies to costs for qualified residential solar panels, a geothermal heat pump, solar water-heating equipment, qualified solar electric property costs and small wind-energy property. This credit has no dollar limit or principal-residence requirement. A second 30% credit for qualified fuel-cell plantshas principal-residence and kilowatt-capacity requirements, and cannot be greater than $500 for each 0.5 kilowatt of capacity.

INVESTMENTS

Investment Strategies

Strategy and timing are as important as skill in investing, particularly with regard to taxes. There are a number of tax-smart investment strategies you may want to consider, especially in light of legislation that has lowered the tax rate on dividends and capital gains.These same strategies can be applied during today’s difficult economic times when many people have suffered substantial investment losses. However, be aware that Congress may make changes to them in the future.

Dividends

Qualified dividend income received by an individual shareholder is taxed at a top rate of 15%. It is taxed at 0% for taxpayers in the 10% or 15% income tax bracket.

Capital Gains Tax

The maximum tax rate on net capital gains remains at 15% for 2011. If you’re in the 10%or 15% income tax bracket, your tax rate on net capital gains is zero, and you will not be taxed for 2011. The Tax Relief, Unemployment Insurance Reauthorization and Jobs Creation Act of 2010 extended these tax rates through 2012.

To qualify for long-term tax treatment, an asset must generally be held for more than one year before it is sold. Capital gains on investments held for one year or less are taxed at regular income tax rates.

Offset Capital Gains with Losses

When it comes to investment decisions, knowing when to make a move is critical. Then there are times, such as those we are experiencing today, when many of our conventional ideas about investing are dramatically challenged. Many of you may be finding yourselves buying high and selling low, creating a loss.In 2011, capital losses are netted against capital gains. If your capital losses exceed your capital gains, you can deduct up to $3,000 of your combined long-term and short-term capital losses against ordinary income.

Any remaining net capital losses may be carried forward to future years and can be used to offset future gains. It is very important to keep track of these unused losses and whether they are short-term or long-term losses.

Keep in mind that an investment sold at a loss in 2011 need not be gone forever. If you believe it was a good long-term investment, you can buy it back. Just be sure to wait at least 31 days after the sale. Otherwise you’ll get caught up in the wash sale rule. This rule disallows losses on securities sold if substantially identical securities are bought within 30 days before or after the date of the sale, creating a 61-day wash-sale period, although the definition of “substantially identical” provides some flexibility.

RETIREMENT

Retirement Strategies

We all know that contributing to a retirement plan is a key step when working toward a secure retirement, but did you know it can lower your current income tax bill as well?

Employer Sponsored Plans

Pre-tax contributions to an employer-sponsored retirement plan reduce the amount of taxable wages you report on your tax return, making qualified retirement plans an excellent way to cut your tax bill. Matching contributions and income earned within your plan are also tax deferred. If you have a 401(k) and you haven’t arranged to contribute the maximum, try to increase your contributions before year end. This is especially important if your employer makes matching contributions, which, in effect, represents free money. For 2011, if you’re under age 50, your maximum contribution to a 401(k) plan is $16,500. Taxpayers who are age 50 or older by the end of 2011 can make an additional $5,500 “catch-up” contribution for that calendar year to reach $22,000 for 2011.

Individual Retirement Accounts (IRAs)

The top annual contribution for traditional or Roth IRAs remains at $5,000 for 2011. If you’re age 50 or older by the end of 2011, you can make an additional $1,000 “catch-up” contribution. You cannot contribute more than your qualifying income for the year, but if your spouse has little or no income, you can contribute to either a traditional IRA or Roth IRA for your spouse based on your earnings.

Traditional IRA contributions may be deductible depending on your modified AGI and whether you or your spouse (if filing jointly) is covered by an employer-sponsored retirement plan. Also, you must begin to take minimum required distributions from the IRA once you reach age 70 ½, but this does not apply to Roth IRAs.

Roth IRA contributions are not deductible, but you can withdraw them at any time tax free. You can also withdraw earnings on contributions tax free after five years if you are age 59½ or older, disabled or paying qualifying first-time homebuyer expenses.

You have until the filing deadline of April 17, 2012 to open and contribute to an IRA for 2011. But why wait? The sooner you contribute, the longer your money grows tax deferred or tax free.

Conversion to Roth IRA

Regardless of your filing status or income, you can convert traditional IRAs to Roth IRAs, with no dollar limit on the amount converted. However, the entire transfer must be reported as income unless after-tax contributions were made to any of your traditional IRAs. Although income tax is due on the amount converted, the 10% early-distribution penalty does not apply if you are under age 59½ and keep the funds in the Roth IRA for at least five years.  There is no modified AGI requirement needed for a conversion and it can be reversed no later than the extended due date for the 2012 tax return.

Your Warren Averett Wilson Price CPA can help you decide whether a conversion to a Roth IRA is best for you.

Key Takeaways

This was a lot to cover, but the key takeaways for you are these:

• First, remember that your CPA can be a valuable partner in providing answers to your questions and helping to keep your tax bill to a minimum.
• Second, don’t hesitate to ask a lot of questions to make sure you understand the advice you are being given.
• Third, don’t wait until tax time to seek professional tax assistance. Your Warren Averett Wilson Price CPA can help you plan for tax savings throughout the year.

If you have any questions regarding these tax developments, please contact your Warren Averett Wilson Price Division accountant.

Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

President’s FY 2013 budget proposals carry numerous tax changes

On February 13, the President released his federal budget proposals for fiscal year 2013, and, on the same day, the Treasury released its “General Explanations of the Administration’s Fiscal Year 2013 Revenue Proposals” (the so-called “Green Book”). The revenue proposals include over 130 large and small proposed tax changes for businesses and individuals, including new incentives to “insource” jobs, higher taxes for upper-income taxpayers, and the extension of key tax breaks. Here is a run down of the domestic tax proposals.

Business Tax Proposals

The budget’s proposals for business include the following.

• FICA Cut Extended.The payroll tax cut currently in place for January and February of this year would be extended for the rest of 2012.
• Wage Credit.Qualified employers would be provided a tax credit for increases in wage expense, whether driven by new hires, increased wages, or both. The credit would be equal to 10% of the increase in the employer’s 2012 eligible wages (OASDI wages) over the prior year (2011). The maximum amount of the increase in eligible wages would be $5 million per employer, for a maximum credit of $500,000, to focus the benefit on small businesses. For employers with no OASDI wages in 2011, eligible wages for 2011 would be 80% of their OASDI wage base for 2012. The credit would generally be considered a general business credit. A similar credit would be provided for qualified tax-exempt employers. The credit would be effective for wages paid during the one-year period beginning on Jan. 1, 2012.
• FUTA.Employers currently pay FUTA tax at a rate of 6.0% (beginning July 1, 2011) on the first $7,000 of covered wages paid annually to each employee. The rate for the first half of 2011 was 6.2%, including the 6% permanent tax rate and the 0.2% temporary surtax that expired on June 30, 2011. The net federal unemployment insurance tax on employers would permanently revert to 6.2%, effective for wages paid with respect to employment on or after Jan. 1, 2013. Also, under current law, employers in States that meet certain Federal requirements are allowed a credit against FUTA taxes of up to 5.4%, making the minimum net Federal rate 0.6%. States that become non-compliant are subject to a reduction in FUTA credit, causing employers to face a higher Federal UI tax. Effective on the enactment date, short-term relief would be provided, for example, the FUTA credit reduction for employers in borrowing States would be suspended in 2012 and 2013. Other changes would be made. For example, the FUTA wage base would be raised in 2015 to $15,000 per worker.
• Bonus Depreciation.  The 100% bonus first-year depreciation deduction that generally applies only for assets placed in service before 2012, would be extended through 2012.
• LIFO Repeal.  Use of the last-in, first-out (LIFO) accounting method would be repealed, for tax years beginning after Dec. 31, 2013. Taxpayers required to change from the LIFO method also would be required to report their beginning-of-year inventory at its first-in, first-out (FIFO) value in the year of change, causing a one-time increase in taxable income that would be recognized ratably over 10 years.
• Lower of Cost or Market Repeal.  For tax years beginning after Dec. 31, 2013, bar the use of the lower-of-cost-or market and subnormal goods methods of inventory accounting, which currently allow certain taxpayers to take cost-of-goods-sold deductions on certain merchandise before the merchandise is sold. Any resulting income inclusion would be recognized over a four-year period beginning with the change year.
• Energy Credits.  An additional $5 billion of credits for investments in eligible property used in a qualifying advanced energy manufacturing project. Taxpayers would be able to apply for a credit with respect to part or all of their qualified investment. Applications for the additional credits would be made during the two-year period beginning on the date on which the additional authorization is enacted.
• More Energy Credits.  Replace the existing deduction for energy efficient commercial building property with a tax credit equal to the cost of property that is certified as being installed as part of a plan designed to reduce the total annual energy and power costs with respect to the interior lighting, heating, cooling, ventilation, and hot water systems of the building by 20% or more in comparison to a reference building which meets certain minimum requirements. The tax credit would be available for property placed in service during calendar year 2013.
• Build America Bonds.Effective for bonds issued after the enactment date, make the Build America Bonds program permanent at a Federal subsidy level equal to 30% through 2013 and 28% of the coupon interest on the bonds thereafter. The 28% Federal subsidy level would be intended to be approximately revenue neutral relative to the estimated future Federal tax expenditure for tax-exempt bonds. The eligible uses for Build America Bonds also would be expanded.
• IRAs.Effective after 2013, require employers in business for at least two years that have more than ten employees to offer an automatic IRA option to employees, under which regular contributions would be made to an IRA on a payroll-deduction basis. If the employer sponsored a qualified retirement plan, SEP, or SIMPLE for its employees, it would not be required to provide an automatic IRA option for its employees. Additionally, the non-refundable “start-up costs” tax credit for a small employer that adopts a new qualified retirement, SEP, or SIMPLE would be doubled from the current maximum of $500 per year for three years to a maximum of $1,000 per year for three years and extended to four years (rather than three) for any employer that adopts a new qualified retirement plan, SEP, or SIMPLE during the three years beginning when it first offers (or first is required to offer) an automatic IRA arrangement. This expanded “start-up costs” credit for small employers, like the current “start-up costs” credit, would not apply to automatic or other payroll deduction IRAs.
• Qualified Small Business Stock.  For qualified small business stock (QSBS) acquired after Dec. 31, 2011, make the 100% exclusion for qualified small business stock permanent. The AMT preference item for gain excluded under Code Sec. 1202 would be repealed for all excluded small business stock gain. Also, the time for a taxpayer to reinvest the proceeds of sales of small business stock under Code Sec. 1045 would be increased to 6 months for qualified small business stock the taxpayer has held longer than three years.
• Start-up Expenditures.  For tax years ending on or after the date of enactment, the maximum amount of start-up expenditures that a taxpayer may deduct (in addition to amortized amounts) in the tax year in which a trade or business begins, would be permanently doubled from $5,000 to $10,000. This maximum amount of expensed start-up expenditures would be reduced (but not below zero) by the amount by which start-up expenditures with respect to the active trade or business exceed $60,000.
• Health Insurance Tax Credit.  For tax years beginning after Dec. 31, 2011, liberalize the tax credit available to small employers providing health insurance to employees. For example, the group of employers who are eligible for the credit would be expanded to include employers with up to 50 full-time equivalent employees and the phase-out would begin at 20 full-time equivalent employees.
• Jet Depreciation.  Require corporate business jets that carry passengers to be depreciated over seven years instead of five, effective for property placed in service after Dec. 31, 2012.
• Oil and Gas Tax Preferences.  Eliminate these tax preferences for oil and gas companies, generally effective after Dec. 31, 2012: investment tax credit for enhanced oil recovery projects, production credit for oil and gas from marginal wells, intangible drilling cost deduction, the deduction for tertiary injectants used as part of a tertiary recovery method, the exception to passive loss limits for working interests in oil and natural gas properties, percentage depletion, and two-year amortization of independent producers’ geological and geophysical expenditures (amortization period would be increased to seven years).
• Coal Activity Tax Prefernces.  Eliminate tax preferences for coal activities beginning in 2013 (expensing of exploration and development costs, percentage depletion for hard mineral fossil fuels, capital gains treatment for royalties, and the Code Sec. 199 deduction).
• Tax Carried Interests.  Tax certain “carried interest” as ordinary income, instead of at the 15% capital gains rate.
• Worker Classification.  Permit IRS to issue generally applicable guidance about the proper classification of workers and to require prospective reclassification of workers who are currently misclassified and whose reclassification is prohibited under section 530 of the ’78 Revenue Act. Penalties would be waived for service recipients with only a small number of workers, if they had consistently filed all required information returns reporting all payments to all misclassified workers and agreed to prospective reclassification of misclassified workers. This proposal would apply on enactment, but the prospective reclassification for those covered currently by section 530 of the ’78 Revenue Act would not be effective for at least one year after the enactment date.

Proposals to Boost U.S. Manufacturing and Insourcing of Jobs

To encourage businesses to locate jobs and business activity in the U.S., the President’s budget proposes to make these changes, among others:

• “Buffet Rule”.  Replace the alternative minimum tax with a 30% tax minimum tax on people earning at least $1 million.
• New General Business Credit.  Effective for expenses paid or incurred after the date of enactment, create a new general business credit against income tax equal to 20% of the eligible expenses paid or incurred in connection with insourcing a U.S. trade or business. Insourcing a U.S. trade or business would mean reducing or eliminating a trade or business (or line of business) currently conducted outside the U.S. and starting up, expanding, or otherwise moving the same trade or business within the U.S., to the extent that this action results in an increase in U.S. jobs.
• Disallow Outsourcing Deductions.  Effective for expenses paid or incurred after the date of enactment, deductions for expenses paid or incurred in connection with outsourcing a U.S. trade or business would be disallowed. Outsourcing a U.S. trade or business would mean reducing or eliminating a trade or business or line of business currently conducted inside the U.S. and starting up, expanding, or otherwise moving the same trade or business outside the U.S., to the extent that this action results in a loss of U.S. jobs.
• Credit for Communities with Job LossesCreation of a new allocated tax credit to support investments in communities that have suffered a major job loss event (i.e., when a military base closes or a major employer closes or substantially reduces a facility or operating unit, resulting in a long-term mass layoff). About $2 billion in credits would be provided for qualified investments approved in each of the three years, 2012 through 2014.
• Cut Back Domestic Production Deduction.  For tax years beginning after Dec. 31, 2012, limit the extent to which the Code Sec. 199 domestic production deduction is allowed with respect to nonmanufacturing activities by excluding from the definition of domestic production gross receipts (DPGR) any gross receipts derived from sources such as the production of oil and gas, the production of coal and other hard mineral fossil fuels, and certain other nonmanufacturing activities. Additional revenue obtained from this retargeting would be used to increase the general deduction percentage and to fund an increase of the deduction rate for activities involving the manufacture of certain advanced technology property to approximately 18%.
• R&D Credit.  Retroactively effective after Dec. 31, 2011, make the research credit permanent and increase the rate of the alternative simplified research credit from 14% to 17%.

Tax Changes for Individuals

The President’s plan calls for numerous changes to be made for individuals, including the following:

• Reinstate Deduction Phase-outs.  For tax years beginning after Dec. 31, 2012, reinstatement of upper-income taxpayers’ reduction of itemized deductions and phaseout of personal exemptions.
• Bush era Tax Cuts.  The expiration of the 2001 and 2003 (EGTRRA and JGTRRA) tax cuts for those with household income over $250,000 a year for joint filers ($200,000 for single taxpayers), effective after 2012.
• Tax on Dividends.  For dividends received after Dec. 31, 2012, the current reduced tax rates on qualified dividends would expire for income that would be taxable in the 36% or 39.6% brackets. In other words, qualified dividends for upper income taxpayers would be taxed as ordinary income.
• Tax on Long-term Capital Gains.  For long-term capital gains realized after Dec. 31, 2012, the current reduced tax rates on long-term capital gains would expire for capital gain income that, in the absence of any preferential treatment of long-term capital gains, would be taxable in the 36% or 39.6% brackets. Thus, the maximum long-term capital gains tax rate for upper-income taxpayers would be 20%.
• Limit the Benefit of Deductions.  For tax years beginning after Dec. 31, 2012, the tax value of specified deductions or exclusions from AGI and all itemized deductions would be limited to 28% of the specified exclusions and deductions that would otherwise reduce taxable income in the 36% or 39.6% tax brackets. A similar limit also would apply under the alternative minimum tax. The limit would apply to tax-exempt state and local bond interest, employer-sponsored health insurance paid for by employers or with before-tax employee dollars, health insurance costs of self-employed individuals, employee contributions to defined contribution retirement plans and individual retirement arrangements, the deduction for income attributable to domestic production activities, certain trade and business deductions of employees, moving expenses, contributions to health savings accounts and Archer MSAs, interest on education loans, and certain higher education expenses. The change would apply to itemized deductions after they have been reduced by the proposed statutory limit on certain itemized deductions for higher income taxpayers.
• Education Credits.  The budget proposal would make permanent the American Opportunity Tax Credit (AOTC), a partially refundable tax credit worth up to $10,000 per student over four years of college.
• EITC Credit.  For tax years beginning after Dec. 31, 2012, the expansion of the EITC for workers with three or more qualifying children would be made permanent. Specifically, the phase-in rate of the EITC for workers with three or more qualifying children would be maintained at 45%, resulting in a higher maximum credit amount and a longer phase-out range.
• Child Care Credit.  For tax years beginning after Dec. 31, 2012, the AGI level at which the child and dependent care credit begins to phase down would permanently increase from $15,000 to $75,000. The percentage of expenses for which a credit may be taken would decrease at a rate of 1 percentage point for every $2,000 (or part thereof) of AGI over $75,000 until the percentage reached 20% (at incomes above $103,000).
• Principal Residence COD.  The exclusion for income from the discharge of qualified principal residence indebtedness (QRPI) would be extended to amounts that are discharged before Jan. 1, 2015, and to amounts that are discharged pursuant to an agreement entered before that date.

Estate and Gift Tax Proposals

Restoration of transfer tax to 2009 levels.The estate, generation-skipping transfer (GST), and gift tax parameters as they applied during 2009 would be made permanent. The top tax rate would be 45% and the exclusion amount would be $3.5 million for estate and GST taxes, and $1 million for gift taxes. These changes would apply for estates of decedents dying, and for transfers made, after Dec. 31, 2012.

Portable estate tax exclusion made permanent. The provision allowing a surviving spouse to use the deceased spouse’s unused estate tax exclusion, which expires for decedents dying after Dec. 31, 2012, would be made permanent.

Basis consistency and reporting requirement for donated and inherited property.The basis of property in the hands of the recipient could be no greater than the value of that property as determined for estate or gift tax purposes (subject to subsequent adjustments). A reporting requirement would be imposed on executors and donors to provide the necessary valuation and basis information to both the recipient and IRS. These rules would apply for transfers on or after the enactment date.

Toughened rules for valuation discounts.Certain additional restrictions (“disregarded restrictions”) would be ignored under Code Sec. 2704 in valuing an interest in a family-controlled entity transferred to a member of the family if, after the transfer, the restriction will lapse or may be removed by the transferor and/or the transferor’s family. The transferred interest would be valued by substituting for the disregarded restrictions certain assumptions to be specified in regs. These rules would apply to transfers after the enactment date of property subject to restrictions created after Oct. 8, 1990 (the effective date of Code Sec. 2704)

Minimum and maximum term for grantor retained annuity trusts (GRATs).A GRAT would be required to have a minimum term of ten years and a maximum term of the life expectancy of the annuitant plus ten years. Also, the remainder interest would have to have a value greater than zero at the time the interest is created and any decrease in the annuity during the GRAT term would be prohibited. These rules would apply to trusts created after the enactment date.

Duration of GST tax exemption limited.On the 90th anniversary of the creation of a trust, the GST exclusion allocated to the trust would terminate. This rule would apply to trusts created after the enactment date, and to the portion of a preexisting trust attributable to additions to such a trust made after that date.

Coordination of income and transfer tax rules applicable to grantor trusts.The current lack of coordination between the income and transfer tax rules applicable to a grantor trust creates opportunities to structure transactions between the deemed owner and the trust that can result in the transfer of significant wealth by the deemed owner without transfer tax consequences. New rules for grantor trusts would prevent this by: (1) including the assets of the trust in the grantors’ gross estate of that grantor for estate tax purposes, (2) subjecting to gift tax any distribution from the trust to one or more beneficiaries during the grantor’s life, and (3) subjecting to gift tax the remaining trust assets at any time during the grantor’s life if the grantor ceases to be treated as an owner of the trust for income tax purposes. These rules would apply for trusts created on or after the enactment date and with regard to any portion of a pre-enactment trust attributable to a contribution made on or after the enactment date.

Extension of estate tax lien on Code Sec. 6166 deferrals.The estate tax lien under Code Sec. 6324(a)(1) would be extended to apply throughout the Code Sec. 6166 deferral period, effective for estates of decedents dying on or after the effective date and for estates of decedents dying before the enactment date as to which the current law Code Sec. 6324(a)(1) lien period had not expired on the effective date.

Other Proposals

Many expiring provisions would be extended. The Administration proposes to extend a number of provisions that have expired or are scheduled to expire on or before Dec. 31, 2012. For example, the optional deduction for State and local general sales taxes, the deduction for qualified out-of-pocket classroom expenses, the deduction for qualified tuition and related expenses, the Subpart F “active financing” and “look-through” exceptions, and the modified recovery period for qualified leasehold, restaurant, and retail improvements, would be extended through Dec. 31, 2013.

Source: Research Institute of America.

If you have any questions regarding these tax developments, please contact your Warren Averett Wilson Price accountant.

Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

The following is a summary of the many important tax developments that have occurred in the past three months that may affect you, your family, your investments, and your livelihood. Please call us for more information about any of these developments and what steps you should implement to take advantage of favorable developments and to minimize the impact of those that are unfavorable.

Payroll tax cut temporarily extended. The Temporary Payroll Tax Cut Continuation Act of 2011 was enacted late last year. It temporarily extends the two percentage point payroll tax cut for employees, continuing the reduction of their Social Security tax withholding rate from 6.2% to 4.2% of wages paid through Feb. 29, 2012. Shortly after its passage, the IRS instructed employers to implement the new payroll tax rate as soon as possible in 2012 but not later than Jan. 31, 2012. The law also includes a “recapture” provision, which applies only to those employees who receive more than $18,350 in wages during the two-month period (i.e., two-twelfths of the 2012 wage base of $110,100). This provision imposes an additional income tax on these higher-income employees in an amount equal to 2% of the amount of wages they receive during the two-month period in excess of $18,350 (and not greater than $110,100). In addition, under the new law, the social security tax rate for a self-employed individual remains at 10.4%, for self-employment income of up to $18,350 (reduced by wages subject to the lower rate for 2012). Congress is going to try to negotiate a deal to extend the payroll tax cut for all of 2012. If a deal is struck to extend it for the full year, the recapture provision for employees would not apply.

Credit for hiring veterans extended and enhanced. A law enacted last November extended and enhanced a credit for hiring qualified veterans. Before the law was passed, the credit would have been available only if the qualified veteran were hired before Jan. 1, 2012, and only certain veterans were considered qualified veterans. The new law extends the credit for hiring qualified veterans, adds two new classes of veterans who are considered qualified veterans, increases the credit for hiring certain qualified veterans, “fast-tracks” the process for certifying that an individual is a qualified veteran, and provides tax-exempt employers with a credit against payroll tax for hiring qualified veterans. The credit amount varies depending on a number of factors. It can be as high as $9,600 for hiring a qualified disabled veteran. For an employer to qualify for the credit, the qualified veteran must begin work for the employer before Jan. 1, 2013 and other requirements must be met.

New rules for deducting or capitalizing tangible property costs. The IRS has issued new regulations for determining whether amounts paid to acquire, produce, or improve tangible property may be currently deducted as business expenses or must be capitalized. The regulations will affect virtually all taxpayers that acquire, produce, or improve tangible property. They are comprehensive, voluminous and virtually rewrite the rules in this area. For example, they provide detailed definitions of “materials and supplies” and “rotable and temporary spare parts” and prescribe new rules and elective de minimis and optional methods for handling their cost. They also have rules for differentiating between deductible repairs and capitalizable improvements, among many other items. The regulations generally are effective in tax years beginning after Dec. 31, 2011. However, to add to their complexity, some of the new rules in the regulations do not supersede prior IRS guidance.

New foreign asset reporting guidance and form. The IRS issued detailed guidance on the new law requiring individuals with an interest in a “specified foreign financial asset” during the tax year to attach a disclosure statement to their income tax return for any year in which the aggregate value of all such assets is greater than $50,000 (or a dollar amount higher than $50,000 as the IRS may prescribe). In addition, the IRS issued Form 8938 (Statement of Specified Foreign Financial Assets), which individual taxpayers will use starting in the 2012 tax filing season to report specified foreign financial assets for tax year 2011. The guidance consists of detailed temporary regulations. They define terms that apply for purposes of the reporting requirement; provide rules to determine if a specified individual must file a Form 8938 with their annual return; define what are specified foreign financial assets; detail what information needs to be reported; provide guidelines for valuing specified foreign financial assets; list exceptions to the reporting requirements; and describe the penalties that apply for failure to comply with the reporting requirements.

Standard mileage rates flat or lower. The optional mileage allowance for owned or leased autos (including vans, pickups or panel trucks) is 55.5¢ per each business mile traveled after 2011. For 2011, it was 55.5¢ for miles driven after June 30 and 51¢ per mile for miles driven before July 1. Further, the 2012 rate for using a car to get medical care or in connection with a move that qualifies for the moving expense deduction is 23¢ per mile. For 2011, it was 23.5¢ for miles driven after June 30 and 19¢ per mile for miles driven before July 1.

New Form 8949 replaces Form 1040, Schedule D-1. Many transactions that, in previous years, would have been reported on Form 1040, Schedule D or D-1 must be reported on Form 8949 if they occurred in 2011. Specifically, a taxpayer uses Form 8949 to report:

• The sale or exchange of a capital asset not reported on another form or schedule,
• Gains from involuntary conversions (other than from casualty or theft) of capital assets not held for business or profit, and
• Nonbusiness bad debts.

The taxpayer uses Schedule D to figure the overall gain or loss from transactions reported on Form 8949 and to report capital gain distributions not reported directly on Form 1040, line 13, a capital loss carryover from 2010 to 2011, and certain specialized items.

Withholding requirement for government contractors repealed. A law enacted in 2005 was to have required the Federal government and the government of every state, political subdivision of a state, and instrumentality of a state or state subdivision (including multi-state agencies) making certain payments to a person providing any property or services (e.g., payments to a government contractor) to deduct and withhold 3% from that payment. Although the withholding requirement was originally set to apply to payments made after 2010, it was subsequently deferred to apply to payments made after 2012. A law enacted in November 2011 repealed the government contractor withholding requirement.

If you have any questions regarding these tax developments, please contact your Warren Averett Wilson Price Division accountant.

Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

Expiring Business Tax Provisions: According to a Congressional Research Service report dated 12/1/11, the following will expire on 12/31/11: (1) the research and development and the work opportunity tax credits; (2) the enhanced charitable deductions for contributions of food, books, and computer technology; (3) the special S corporation built-in gains tax suspension period; and (4) the 15-year recovery period for leasehold improvements, restaurant property, and retail improvements. Furthermore, the 100% bonus depreciation deduction will be scaled back to 50% in 2012, and the Section 179 deduction limit will fall from $500,000 this year to an inflation-adjusted $139,000 in 2012.

Expiring Individual Tax Provisions: According to the same Congressional Research Service report, the following deductions will expire on 12/31/11: (1) elementary and secondary school teacher expenses, (2) state and local sales taxes, (3) mortgage insurance premiums, and (4) qualified tuition and related expenses. The 2010 Tax Relief Act allowed a taxpayer’s nonrefundable personal credits to offset regular tax (net of any allowable foreign tax credit) and AMT for 2011, and also authorized a reduction in the employee’s share of the Social Security payroll tax to 4.2% for 2011. Congress may extend the payroll tax break, and presumably will pass another (one year) AMT patch. Finally, the tax-free treatment of distributions from IRAs for charitable purposes will expire at the end of 2011.

Recharacterizing S Corporation Distributions: S corporation taxable income passed through to a shareholder-employee and S corporation distributions paid to a shareholder-employee are not subject to federal employment taxes or self-employment tax. While this has tempted some shareholder-employees to reduce or even eliminate their salary to avoid employment taxes, the IRS can recharacterize distributions as disguised salary. In one recent case, the S corporation paid its sole shareholder an annual salary of $24,000, but also made distributions of $320,000 over a two-year period. In holding that $67,000 of each year’s distribution should be treated as salary (on top of the $24,000 salary already paid), the District Court noted that the shareholder was a highly qualified accountant with an advanced degree, and was a primary earner in a reputable firm with $5 million in gross revenue over the two-year period. Watson, P.C. v. U.S. , 107 AFTR 2d 2011-311 (DC Iowa).

Portability Election: Executors for the estates of decedents dying after 12/31/10 must file Form 706 , even if not otherwise required to do so, to make the portability election under IRC Sec. 2010(c)(5) allowing the surviving spouse to use the unused portion of the decedent’s exclusion ($5,000,000 in 2011 and $5,120,000 in 2012). This notice alerted taxpayers that the timely filing of Form 706, prepared in accordance with the instructions, will constitute the appropriate portability election for the unused exclusion. Estates not wanting to make the portability election whose gross value exceeds the applicable exclusion should follow the Form 706 instructions. [IRS Notice 2011-82, 2011-42 IRB 516.

Relief for 2010 Decedents: This notice provided estates of decedents who died in 2010 with additional time to file an estate tax return and to pay the estate tax due. The IRS will not impose late filing and late payment penalties on the estates of decedents who died after 12/31/09 and before 12/17/10 if the estate timely files Form 4768 [Application for Extension of Time to File a Return and/or Pay U.S. Estate (and Generation-Skipping Transfer) Taxes], and then files Form 706 or Form 706-NA and pays the estate tax by 3/19/12. Similar relief is available to the estates of decedents who died after 12/16/10 and before 1/1/11 if the estate timely files Form 4768 and then files Form 706 or Form 706-NA and pays the estate tax within 15 months after the decedent’s death. Furthermore, the due date of Form 8939 (Allocation of Increase in Basis for Property Acquired from a Decedent) is delayed from 11/15/11 to 1/17/12. Finally, this notice provided penalty relief to certain persons who received property whose basis is determined under the Section 1022 carryover basis rules and then disposed of that property during 2010. Notice 2011-76, 2011-40 IRB 479.

Bonus Depreciation: In this revenue procedure, the IRS explained how the 100% bonus depreciation rules under IRC Sec. 168(k) will be applied. In part, the IRS (1) allowed 100% bonus depreciation for qualified restaurant or retail improvement property that also qualify as leasehold improvement property; (2) enabled taxpayers that placed qualified property in service in the tax year that includes 9/9/10 to elect out of bonus depreciation for any class of property, or default into bonus depreciation for the whole year, or claim 50% bonus depreciation for the whole year; and (3) provided a safe harbor method for handling post-year-of acquisition depreciation of autos subject to the Section 280F(a) luxury auto limits. Rev. Proc. 2011-26, 2011-16 IRB 664 .

Employer-provided Cell Phones: Almost a year after the removal of cell phones from the definition of listed property by the 2010 Small Business Jobs Act, the IRS issued guidance treating an employee’s use of a cell phone related to the employer’s business as an excludable working condition fringe benefit under IRC Sec. 132(d) when provided for substantial noncompensatory business reasons. Examples of substantial noncompensatory business reasons for providing a cell phone include the need to contact an employee at all times for work-related emergencies, and the need to speak with clients while away from the office or when the client is in another time zone. Notice 2011-72, 2011-38 IRB 407

Rental Real Estate Activities: Under IRC Sec. 469(c)(7)(A) and Reg. 1.469-9(g) , qualifying taxpayers can elect to treat all interests in rental real estate activities as a single activity. This can help them meet the material participation standard necessary to treat rental real estate losses as nonpassive (and so be used to offset wages, interest, and other nonpassive income). The IRS issued special procedures, in lieu of a letter ruling request, to obtain relief for late elections. To qualify, the taxpayer must have reasonable cause for failing to meet the election requirements, and must have filed all tax returns as if the election had been made. Rev. Proc. 2011-34, 2011-24 IRB 875.

Sale of Professional Practice: In this case, the 9th Circuit affirmed a District Court’s finding that amounts received by the taxpayer for personal goodwill from the sale of his dental practice represented the sale of a corporate asset and a subsequent dividend distribution. In the same year the taxpayer incorporated his dental practice, he entered into a covenant not to compete with the corporation. As an employee of the corporation with a covenant not to compete, any goodwill generated from his professional work belonged to the corporation. While the patient relationships were personal, the economic value of those relationships did not belong to the taxpayer. Howard v. U.S. , 108 AFTR 2d 2011-5993 (9th Cir.).

Standard Mileage Rates: The IRS raised the standard mileage rates for the last six months of 2011 to 55.5 cents per mile for business miles driven and 23.5 cents per mile for medical or moving expenses-both a 4.5 cent per mile increase over the rates in effect for the first six months of the year. The rates for 2012 will be 55.5 cents per mile for business miles (with 23 cents per mile treated as depreciation) and 23 cents per mile for medical or moving expenses. (This means the rate for business miles is unchanged from the midyear adjustment that took effect on 7/1/11.) The rate for providing services for a charity is set by statute and equals 14 cents per mile. IRS Ann. 2011-40, 2011-29 IRB 56 ; Notice 2012-1, 2012-1 IRB 1 .

If you would like to discuss these, or other matters, further,
please contact your Wilson Price accountant.

 

Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

The 2010 Tax Relief Act provided bigger depreciation deductions for business assets. In fact, under Section 179, businesses can expense up to $500,000 of depreciable business assets acquired during 2011, with any remaining basis fully deducted using the 100% bonus depreciation. Unfortunately, unfavorable depreciation rules apply to most passenger autos and light trucks used in business. For a vehicle acquired in 2011, depreciation deductions are generally limited to the following amounts: 

		New Cars (With Bonus Depreciation)		Used Cars (No Bonus Depreciation)		New Light Trucks and Vans (With Bonus Depreciation)		Used Light trucks and Vans (No Bonus Depreciation)
Year 1		$  11,060		$    3,060		$  11,260		$    3,260
Year 2		4,900		4,900		5,200		5,200
Year 3		2,950		2,950		3,150		3,150
Year 4 and thereafter		1,775		1,775		1,875		1,875

Of course, when a vehicle is used less than 100% for business, these figures are cut back even further. In fact, the average client may not live long enough to fully depreciate a really expensive car.

Exception for Heavy Trucks, Vans, and Sport Utility Vehicles (SUVs).

These vehicles are not subject to the above limits. A truck, van, or SUV is “heavy” if it has a Gross Vehicle Weight Rating (GVWR) (the manufacturer’s maximum weight rating when loaded) above 6,000 pounds.  We’ve listed below many of the 2012 vehicle models that qualify for these special tax benefits based on their GVWRs at the time we checked them. As you can see, it’s a surprisingly long list. In addition, there may be some we have missed (new and retooled models are coming out all the time). Thus, always verify the GVWR for yourself before making a buying decision. The GVWR can normally be found on a label attached to the inside edge of the driver’s side door.

If you buy such a vehicle in 2011 and use it more than 50% for business, you may be able to deduct the entire business portion of the vehicle’s cost this year. For example, if before the end of the year you buy a new $65,000 heavy SUV that has a gross vehicle weight above 6,000 pounds and is used 100% for business, you may be able to deduct the entire $65,000 this year.

To claim these deductions, you must establish through contemporaneous records (such as, a mileage log) that you use the vehicle over 50% of the time for business. If your business usage later falls below 51%, a portion of the deductions previously claimed will need to be recaptured and reported as ordinary income in that year. Also, deductions allowable for used vehicles may be limited as such vehicles do not qualify for 100% bonus depreciation. Finally, this strategy works best if you are self-employed-claiming a Section 179 and bonus depreciation deductions for a heavy corporate-owned vehicle is much more difficult. Nevertheless, the heavy vehicle deductions can generate major tax savings given the right circumstances.

If you would like more details, please do not hesitate to call.

Vehicles with GVWRs above 6,000 Pounds

Audi		Infinity
Audi Q7		QX56
BMW		Jeep
X5 MX6 M		Grand Cherokee
Buick		Land Rover
Enclave		LR4
		Range Rover
Cadillac		Lexus
Escalade		GX460
		LX570
Chevrolet
Avalanche		Lincoln
Express van		Navigator
Silverado
Suburban		Mercedes
Tahoe		G Class
Traverse		GL Class
		M Class
Dodge		R Class
Dakota2
Durango2		Nissan
Ram		Armada
		NV
Ford		Pathfinder
Expedition		Titan
Explorer
F150		Porsche
F250		Cayenne
F350
F450		Toyota
		4Runner
GMC		Land Cruiser
Acadia		Sequoia
Savana		Tundra
Sierra
Yukon		Volkswagon
		Touareg
Honda
Pilot		Volvo
Ridgeline	__	XC90

 

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Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.