Vernoia, Enterline + Brewer, CPA LLC

Archive for January, 2013

How do I? Get the most from my inherited IRA?

Individual Retirement Accounts (IRAs) are popular retirement savings vehicles that enable taxpayers to build their nest egg slowly over the years and enjoy tax benefits as well. But what happens to that nest egg when the IRA owner passes away?

The answer to that question depends on who inherits the IRA. Surviving spouses are subject to different rules than other beneficiaries. And if there are multiple beneficiaries (for example if the owner left the IRA assets to several children), the rules can be complicated. But here are the basics:


Upon the IRA owner’s death, his (or her) surviving spouse may elect to treat the IRA account as his or her own. That means that the surviving spouse could name a beneficiary for the assets, continue to contribute to the IRA, and would also avoid having to take distributions. This might be a good option for surviving spouses who are not yet near retirement age and who wish to avoid the extra 10-percent tax on early distributions from an IRA.

A surviving spouse may also rollover the IRA funds into another plan, such as a qualified employer plan, qualified employee annuity plan (section 403(a) plan), or other deferred compensation plan and take distributions as a beneficiary. Distributions would be determined by the required minimum distribution (RMD) rules based on the surviving spouse’s life expectancy.

In the alternative, a spouse could disclaim up to 100 percent of the IRA assets. Some surviving spouses might choose this latter option so that their children could inherit the IRA assets and/or to avoid extra taxable income.

Finally, the surviving spouse could take all of the IRA assets out in one lump-sum. However, lump-sum withdrawals (even from a Roth IRA) can subject a spouse to federal taxes if he or she does not carefully check and meet the requirements.

Non-spousal inherited IRAs

Different rules apply to an individual beneficiary, who is not a surviving spouse. First of all, the beneficiary may not elect to treat the IRA has his or her own. That means the beneficiary cannot continue to make contributions.

The beneficiary may, however, elect to take out the assets in a lump-sum cash distribution. However, this may subject the beneficiary to federal taxes that could take away a significant portion of the assets. Conversely, beneficiaries may also disclaim all or part of the assets in the IRA for up to nine months after the IRA owner’s death.

The beneficiary may also take distributions from the account based on the beneficiary’s age. If the beneficiary is older than the IRA owner, then the beneficiary may take distributions based on the IRA owner’s age.

If there are multiple beneficiaries, the distribution amounts are based on the oldest beneficiary’s age. Or, in the alternative, multiple beneficiaries can split the inherited IRA into separate accounts, and the RMD rules will apply separately to each separate account.

The rules applying to inherited IRAs can be straightforward or can get complicated quickly, as you can see. If you have just inherited an IRA and need guidance on what to do next, let us know. Likewise, if you are an IRA owner looking to secure your savings for your loved ones in the future, you can save them time and trouble by designating your beneficiary or beneficiaries now. Please contact our office at (908) 725-4414, with any questions.

New 0.9% Medicare Tax

Effective January 1, 2013, a new Medicare tax takes effect. The Additional Medicare Tax imposes a 0.9 percent tax on compensation and self-employment income above a threshold amount.  Unlike regular Medicare tax, the Additional Medicare Tax has no employer match but employers have withholding obligations. The IRS issued proposed reliance regulations about the Additional Medicare Tax in December 2012.


Medicare is funded through payroll taxes.  Employees and employers (and self-employed individuals) all pay into Medicare.  Employees and employers each pay Medicare tax at a rate of 1.45 percent (self-employed individuals pay at a combined rate but are allowed to deduct half of the Medicare tax as an adjustment to income). The Additional Medicare Tax is a new tax that may apply to certain taxpayers in addition to regular Medicare tax.  The new tax was part of the Patient Protection and Affordable Care Act (Affordable Care Act), which was passed by Congress in 2010.  However, Congress delayed the start date of the new tax until 2013.


Generally, an individual is liable for Additional Medicare Tax if the individual’s wages, compensation, or self-employment income (together with that of his or her spouse if filing a joint return) exceed the threshold amount for the individual’s filing status.  Only individuals with incomes above the threshold amount will be liable for the new tax and if their employer does not withhold it, they will have to pay it when then they file their returns.

The threshold amounts are: $250,000 for married couples filing jointly; $200,000 for single individuals, head of household (with qualifying person) and qualifying widow(er) with dependent child; and $125,000 for married couples filing separately.


An employer must withhold Additional Medicare Tax from wages it pays to an individual in excess of $200,000 in a calendar year, without regard to the individual’s filing status or wages paid by another employer.  The IRS explained in its proposed reliance regulations that the employer has this withholding obligation even though an employee may not be liable for Additional Medicare Tax because, for example, the employee’s wages together with that of his or her spouse do not exceed the $250,000 threshold for married couples filing jointly.

Let’s look at an example from the IRS proposed reliance regulations:

Elena, who is married and files a joint return, receives $100,000 in wages from her employer for the calendar year. Caleb, Elena’s spouse, receives $300,000 in wages from his employer for the same calendar year. Elena’s wages are not in excess of $200,000, so her employer does not withhold Additional Medicare Tax. Caleb’s employer is required to collect Additional Medicare Tax only with respect to wages it pays which are in excess of the $200,000 threshold (that is, $100,000) for the calendar year.

Planning considerations

Taxpayers who believe they may be liable for the Additional Medicare Tax in 2013 and beyond should carefully plan ahead.  The IRS has cautioned that an individual may owe more than the amount withheld by the employer, depending on the individual’s filing status, wages, compensation, and self-employment income.  All these factors come into play in planning for the Additional Medicare Tax.

One strategy may be to make estimated tax payments and/or request additional income tax withholding.  Our office can help you determine which strategy would work best for you.


There is no employer match for the Additional Medicare Tax. However, the Affordable Care Act and the IRS proposed reliance regulations require employers to withhold Additional Medicare Tax on wages it pays to an employee in excess of $200,000 in a calendar year, beginning January 1, 2013.  If an employer fails to withhold, the IRS may impose penalties on the employer and the employee would be liable for the tax.

Reliance regulations

The regulations issued by the IRS in December 2012 are proposed reliance regulations.  The IRS explained that it intends to finalize the proposed regulations in 2013. Taxpayers may rely on the proposed regulations for tax period beginning before the date that the regulations are finalized.

If you have any questions about the Additional Medicare Tax, please contact our office at (908) 725-4414.

IRS clarifies new 3.8% Surtax on Net Investment Income

The IRS has issued proposed reliance regulations on the 3.8 percent surtax on net investment income (NII), enacted in the 2010 Health Care and Education Reconciliation Act. The regulations are proposed to be effective January 1, 2014. However, since the tax applies beginning January 1, 2013, the IRS stated that taxpayers may rely on the proposed regulations for 2013. The IRS expects to issue final regulations sometime later this year.

The surtax applies to individuals, estates, and trusts. The surtax applies if the taxpayer has NII and his or her “modified” adjusted gross income exceeds certain statutory thresholds: $250,000 for married taxpayers and surviving spouses; $125,000 for married filing separately; and $200,000 for individuals and other taxpayers. The tax is broad and can raise tax bills by hundreds, if not thousands, of dollars.

Complex provisions

The regulations are extensive and complex. They address a number of issues that were not answered in the statute, such as the interaction of Code Sec. 1411 (the surtax provisions) and Code Sec. 469 (passive activity loss rules). Significant areas addressed in the proposed regulations include:

  • Identification of those individualssubject to the surtax,
  • Surtax’s application to estatesand trusts,
  • Definition of NII,
  • Disposition of interests inpartnerships and S corporations,
  • Allocable deductions from NII,
  • Treatment of qualified plandistributions, and
  • Treatment of earnings by controlled foreign corporations and passive foreign investment companies.

Some issues, however, are not yet addressed, such as the application of the Code Sec. 469 material participation rules to trusts and estates. Further guidance from the IRS is expected.

Borrowed definitions and principles

Net investment income that is subject to the new 3.8 percent tax generally includes interest and dividend income as well as capital gains from investments.  But Code Sec. 1411 doesn’t stop there, seeking to tax “passive activities” and contrasting those activities with a “trade or business” in often complex ways.

Because Code Sec. 1411 does not define many important terms, the regulations use definitions from several other Tax Code provisions. For example, the definition of a trade or business is determined under Code Sec. 162, regarding trade or business expenses. This definition is essential to Code Sec. 1411, since the application of each of the three categories of net investment income depends on determining whether the income is from a trade or business. The regulations also borrow the definition of a disposition, which applies to category (iii) income, from other provisions, such as Code Section 731 (partnership distributions) and Code Sec. 1001 (dispositions of property).

New elections available

The regulations provide certain elections that may be beneficial to many taxpayers. Taxpayers that engage in multiple activities under Code Sec. are allowed to make another election to regroup their activities. Taxpayers married to a nonresident alien can elect to treat their spouse as a U.S. resident, which allow more income to escape the 3.8 percent surtax.

Net investment income generally includes interest and dividend income as well as capital gains from investments. To prevent avoidance of the tax, the regulations include substitute payments of interest and dividends in the definition. The IRS also warned in the preamble to the proposed regulations that it will scrutinize activities designed to circumvent the surtax and will challenge questionable transactions using applicable statutes and judicial doctrines. The IRS further warned that taxpayers should figure their exposure to the 3.8 percent tax quickly since liability for this additional tax must be included in quarterly estimated tax computations and payments starting with first quarter 2013.

Please feel free to contact this office at (908) 725-4414  for a personalized review of how the 3.8 percent tax may impact you, and what compliance and planning steps should be considered as a consequence.

Taxpayer Relief Act of 2012 now law

In what undeniably came down to the wire in the early hours of January 1, 2013, the Senate passed the American Taxpayer Relief Act of 2012, which, along with many other provisions, permanently extends the so-called Bush-era tax cuts for individuals making under $400,000 and families making under $450,000 (those above those thresholds now pay at a 39.6 percent rate). The House followed with passage late in the day on January 1; and President Obama signed the bill into law on January 2. Thus, the more than decade-long fight over the fate of the tax cuts, originally enacted under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), accelerated under the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) and extended by Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Tax Relief Act) comes to an end.

Prelude to the Fiscal Cliff

On May 26, 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). The legislation was hailed as the largest tax cut in 20 years and dramatically changed the landscape of the federal tax code. Two years later, the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) was signed into law and accelerated many of the tax cuts set in motion under EGTRRA. Originally scheduled to sunset, or expire, after December 31, 2010, Congress extended these popular provisions for another two years in late 2010 with the passage of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. In 2010, Congress acted before the end of the year to extend the cuts. At the end of 2012, Congress and President Obama engaged in intense negotiations over the “fiscal cliff,” a term that came to combine many federal laws that had a deadline of December 31, 2012, including the Bush-era tax cuts. Congress then passed the American Taxpayer Relief Act of 2012 on New Year’s Day, 2013, effectively averting the fiscal cliff.

What Does This Mean for You?

The new law extends a majority of the Bush-era tax cuts in the same form as they have existed since 2001 or 2003 when initially enacted. However, major exceptions include a rise in rates, including a maximum 20 percent on capital gains and dividends, on higher-income individuals, as described above, and an increase in the estate tax rate from 35 to 40 percent. In addition to a general extension of the tax rates, many other provisions, including some not affected by the sunset of the Bush-era tax cuts, are significantly or permanently extended, including:

  • Marriage penalty relief;
  • Inflation protection against the alternative minimum tax (AMT);
  • Deductions for student loan interest and tuition and fees;
  • Enhanced child tax and child and dependent care credits;
  • Simplified earned income credit;
  • Deductions for primary and secondary school teacher expenses;
  • Deductions for state and local sales taxes;
  • Research credits;
  • Energy-efficiency credits for homes and vehicles; and
  • Many more provisions.

Unfortunately, the new law is also significant in what it does not do in one important respect. It does not renew the so-called payroll tax holiday that had been in effect during 2011 and 2012. As a result, employees and self-employed individuals will be paying 2 percent more employment tax on their earnings up to the Social Security wage base (which is up to $113,700 for 2013).

Finally, the American Taxpayer Relief Act also includes extensions of provisions that expired at the end of 2011, but now apply to the 2012 tax year. That means it has immediate effect on the 2013 filing season.

The landscape of federal tax law has changed once again, and with it the need to reassess present tax strategies. Please call our office at (908) 725-4414, if you have any questions about the new law or how it impacts you directly.