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Archive for September, 2013

How do I, compute the American Opportunity Tax Credit?

The American Taxpayer Relief Act of 2012, signed into law on January 2, 2013, extended the American Opportunity Tax Credit through (and including) the 2017 tax year. The credit, which is an enhanced version of the Hope tax credit for tuition, allows taxpayers to claim a credit against federal income taxes for costs of tuition and other qualified educational expenses paid for the taxpayer, his or her spouse, or a dependent claimed on the tax return who is enrolled at an eligible educational institution. An eligible educational institution would include any accredited public, nonprofit, or private college, university, vocational school, or other post-secondary institution.

The maximum American Opportunity Tax Credit amount is $2,500 per eligible student per year, and it is available for each of the first four years of a student’s post-secondary education. (This represents an increase from the Hope credit maximum amount of $1,800 for each of the first two years of post-secondary education.)

The American Opportunity Tax Credit amount is not $2,500 across the board for each claimant, however. Broken down, the maximum credit amount is more accurately stated as being 100 percent of the first $2,000 of qualified tuition and related expenses, plus 25 percent of the next $2,000 of qualified tuition and related expenses. If, by way of an example, a taxpayer had only $3,000 of total qualified tuition and other related expenses, the maximum credit amount the taxpayer could claim would be $2,250. In addition, the credit is also partially refundable if a taxpayer’s total tax liability is less than the amount of the credit. Up to 40 percent of the credit amount is refundable.

The American Opportunity Tax Credit v. other educational benefits

The American Opportunity Tax Credit is one of several education tax benefits available to taxpayers, but because it cannot always be used in conjunction with these other benefits, taxpayers should compute their tax savings for each tax benefit and then decide which one claim. For example, a taxpayer cannot claim a tuition and fees tax deduction in the same taxable year that he or she claims either the American Opportunity Tax Credit or the Lifetime Learning Credit. Neither can a taxpayer claim the Lifetime Learning Credit for any student if he or she has opted to claim the American Opportunity Credit for that same student for the same tax year.

A taxpayer may, however, claim both an education tax credit and take distributions from a Coverdell Education Savings Account or a Qualified Tuition Program. The taxpayer must, however, subtract any qualified expenses used to figure the education credit from the amount of qualified expenses he or she subsequently uses to determine what portion of a distribution from a Coverdell ESA or a qualified tuition program is tax-free.

Before computing an education credit or deduction, the taxpayer should also determine whether or not the credit can be used towards those particular educational expenses. For example, the American Opportunity Tax Credit can be used not just toward tuition, but also toward expenses for books, equipment, and supplies that are required for coursework, but are not required as a condition of enrollment. The Lifetime Learning Credit on the other hand cannot be used for such expenses unless they are a condition of enrollment. However, the American Opportunity Tax credit can only be used for qualified education expenses incurred during each of the first four years of post-secondary education, whereas the Lifetime Learning Credit can be used toward graduate school expenses.

Other differences include that the American Opportunity Tax Credit can be used on a per student basis, meaning if one household has two qualified students, the tax return can claim two American Opportunity Tax Credits. But only one Lifetime Learning Credit can be claimed per return.

The American Opportunity Tax Credit, however, imposes a requirement that the student for whom the credit is claimed has no felony drug convictions. The Lifetime Learning Credit has no such requirement.

We will assume for now that the taxpayer has decided to go ahead and calculate the amount he or she can claim for an American Opportunity Tax Credit. The next question to ask is whether a taxpayer’s adjusted gross income (AGI) falls beneath the phase-out limit. The credit was designed for lower- and middle- income families, meaning higher-income families generally cannot claim the credit.

Who is eligible?

A taxpayer can claim the American Opportunity Tax Credit for qualified expenses paid by the taxpayer for the post-secondary education of the taxpayer, the taxpayer’s spouse, or the taxpayer’s claimed dependent for the tax year for which the credit is claimed. There is a threshold on the amount of adjusted gross income (AGI) a taxpayer can have before the credit amount begins to phase out. The credit amount begins to phase out for single filers, heads of household, and qualifying widowers with AGI of $80,000 and completely phases out for these taxpayers if their AGI exceeds $90,000. The threshold range for married taxpayers who file jointly is from $160,000 to $180,000. Married taxpayers who file separately cannot claim the credit.

Computing the credit

Step One: Computing total qualified education expenses. In order to compute the amount of the American Opportunity Tax Credit a taxpayer must first add up all his or her qualified education expenses. Generally, qualified education expenses are amounts paid during the tax year toward tuition and fees required for the student’s enrollment or attendance at an eligible educational institution. Often an educational institution will issue to the taxpayer a Form 1098-T, Tuition Statement, which includes the amount of tuition a taxpayer paid for that tax year. However, the IRS has warned that this amount can differ from the amount the taxpayer actually paid. For purposes of computing the credit, the IRS directs the taxpayer to use only the tuition amounts that he or she actually paid during the tax year.

Qualified education expenses do not include costs of room and board, insurance, medical expenses (including student health fees), transportation, and other similar personal, living, or family expenses. The costs associated with courses involving sports, games, or hobbies, or any noncredit course are generally not qualified education expenses unless such course or other education is part of the student’s degree program. As we stated above, taxpayers calculating the American Opportunity Tax Credit can also include amounts spent on books, supplies, and equipment that are required for a course of study in their qualified education expenses.

Step Two: Adjusting the amount of qualified educational expenses. The taxpayer must subtract from his or her total qualified educational expenses amounts received as tax-free educational assistance received during the tax year that are allocable to the particular academic period in question. Tax-free educational assistance includes:

  • The tax-free part of any scholarship or fellowship;
  • The tax-free part of any employer-provided educational assistance;
  • Tax-free veterans’ educational assistance, and
  • Any other educational assistance that is excludable from gross income (tax free).

“Tax-free” assistance does not include a gift, bequest, devise, or inheritance. It also does not include any portion of a scholarship or fellowship that must be included in gross income.

If after making these adjustments the amount of qualified education expenses exceeds the maximum credit of $2,500, the taxpayer can only claim $2,500. If the amount is lower than $2,500, the taxpayer can claim the whole amount. (Or less, if the taxpayer’s AGI is within the phase-out range. See Step Three, below.)

Step Three: Calculating any phase-out of the credit. A taxpayer whose AGI falls within the phase out ranges must reduce his or her credit amount ratably. To do this, the taxpayer should subtract his or her AGI from the top threshold amount ($180,000 for married joint filers; $90,000 for single filers, heads of household, and qualifying widowers). Next the taxpayer must divide the difference by either $20,000 (married joint filers) or $10,000 (single filers, heads of household, and qualifying widowers). The resulting quotient should be multiplied by the total amount of qualified education expenses after adjustments for tax-free educational assistance. The product of that should be subtracted from the total amount of qualified education expenses, after adjustments. The result is the amount of the American Opportunity Tax Credit the taxpayer can claim.

For example, if a single taxpayer in 2012 had $85,670 in AGI, he or she must subtract that amount from the top threshold amount for single taxpayers ($90,000). Then he would take the difference ($4,330) and divide it by $10,000. The quotient is .433, meaning the taxpayer must reduce his American Opportunity tax credit amount by 43.3 percent. If, the amount of the taxpayer’s qualified education expenses, after adjustments for scholarships, was $1,600, then the total credit amount that he could claim would be $891.20 because:

$1,600 – ($1,600 × .443) = $891.20

The refundable American Opportunity Tax Credit

If a taxpayer has a tax liability that is lower than the amount of the credit claimed, he or she may be eligible to receive a refundable tax credit of up to 40 percent of the credit amount (a maximum of $1,000). This means, that beyond just lowering a taxpayer’s federal tax liability, a portion of the full credit amount will be returned to the taxpayer in cash as part of the tax refund.

Another set of rules applies for purposes of determining who is eligible for the refundable portion. Generally the rules on refundability appear to be designed to benefit to low-income households with little or no tax liability. Thus, the refundable portion rules seem to exclude from eligibility single filing students, who may have some earned income from a summer job or work-study. The rules state that a taxpayer cannot receive a refundable American Opportunity Tax Credit if the taxpayer:

  • Is under age 18 at the end of the tax year; or
  • Is over age 18 at the end of the tax year and has income that was less than one-half of the taxpayer’s support; or
  • Is between age 18 and 24 at the end of the tax year, a full-time student, and has earned income that was less than one-half of his or her support; and
  • Has at least one living parent at the end of the tax year; and
  • Is not filing a joint return for 2012.

If the taxpayer is eligible for the refundable portion, the taxpayer multiplies the total amount of qualified educational expenses, after adjustments, that he or she is able to claim as an American Opportunity Tax Credit by 40 percent (or .40). That product becomes refundable and is entered onto Form 1040, line 66, in the Payments section of the tax return.

The rules for computing education credits and deductions can be confusing. Please contact our offices at (908) 725-4414 with any questions.

FAQs-Important provisions to Affordable Care Act?

The Patient Protection and Affordable Care Act (PPACA)-the Obama administration’s health care reform law-was enacted in 2010 and many of its provisions have taken effect. But other important provisions will first take effect in 2014 and 2015. These provisions of the law will require affected parties to take action-or at least to be aware of the law’s impact-in 2013 and 2014. These provisions affect individuals, families, employers, and health insurers, among others.

Individual mandate

The individual mandate will apply beginning in 2014. The mandate applies separately for each month. Individuals and their dependents must either carry health insurance or pay a penalty, known as the individual shared responsibility payment. The health insurance must qualify as minimum essential coverage (MEC). Most employer-offered plans, as well as Medicare and Medicaid, qualify as MEC. Certain groups are exempt from the individual mandate, including members of a health sharing ministry, taxpayers without an income tax filing requirement, members of federally-recognized Indian tribes, and persons for whom coverage is unaffordable (more than eight percent of the individual’s household income).


Affordable health insurance marketplaces (exchanges) are ramping up and will be open for business October 1, 2013. Exchanges will provide an open enrollment season during which individuals and families without health insurance can sign up for an insurance policy offered through the exchange, effective January 1, 2014. Anyone needing insurance, or looking for cheaper insurance, can use an exchange. Persons who obtain coverage through an exchange will avoid owing a penalty under the individual mandate. Employers have to start notifying existing employees about the existence of exchanges by October 1, 2013, and must notify new employees when hired.

Low-income individuals and families who purchase insurance through an exchange may qualify for the health insurance premium tax credit for 2014 if their household income falls between 100 percent and 400 percent of the federal poverty level for 2013. Individuals who do not have a filing requirement for 2013 do not need to file a return to qualify for the credit. Individuals will generally self-certify as to their eligibility for the credit. Based on this information, the exchange will determine whether the insured person qualifies for the credit. Taxpayers may qualify for an advanced credit; in this case, the exchange will pay the credit directly to the insurer during 2014 to offset a portion of the health insurance premium.

Small employer credit

Small employers may be able to claim the maximum small employer health insurance credit, if the employer has 10 or fewer employees and average wages per employee of $25,000 or less. While the credit has been around since 2010, the amount of the credit increases for 2014 and 2015 to 50 percent of premiums paid for taxable employers, and 35 percent for nonprofit employers.

Employer mandate

The employer mandate (the employer shared responsibility payment) was scheduled to take effect in 2014, but the IRS postponed it until 2015. Nevertheless, during 2014 employers will want to start paying attention to whether they would qualify as an “applicable large employer” (ALE), since status as an ALE for 2015 depends on 2014 employees. An employer who has 50 or more full-time equivalent employees is an ALE. New employers will be treated as an ALE if they “reasonable expect” to have 50 employees. Employers that are members of an affiliated group of companies under Code Sec. 414 must determine their status as ALEs based on the number of employees in the group.

Employers will also want to look at their health insurance offerings. Once the employer mandate applies, employers must offer MEC to 95 percent of their full-time employees. The coverage must also be affordable and must provide minimum value. Employers should look at whether they need to redesign their plan offerings or change the employees’ share of the cost to comply with these requirements. If the employer’s coverage does not satisfy these requirements, if the employee purchases insurance through an exchange, and if an employee qualifies for the insurance premium tax credit, the employer may be responsible for the employer mandate and owe a penalty.

Employer reporting. The requirements for employers and insurers to report health insurance coverage provided to employees and others were also postponed until 2015. Nevertheless, the IRS is encouraging health insurer issuers to experiment with the requirements by filing the necessary reports for 2014. Larger employers also have to report the value of their health insurance coverage on the employee’s Form W-2. The amount reported is not taxable.

Wellness programs. Beginning in 2014, employers may offer wellness programs as part of their health care benefits offered to employees. Employers may offer benefits, such as premium reductions, to employees who satisfy certain health-related requirements.

IRS issues new rules on small employer health insurance credit

Small employers will be able to purchase health insurance for their employees for 2014 and subsequent years through Small Business Health Options Program (SHOP) Marketplaces. Many of these small employers may also be eligible for the Code Sec. 45R tax credit that helps to offset the cost of insurance. In August, the IRS issued new rules on the Code Sec. 45R small employer health insurance credit in the form of proposed regulations. The regulations describe in detail how employers can claim the credit, especially for years after 2013.

Tax credit

The Code Sec. 45R credit was created by the Patient Protection and Affordable Care Act (Affordable Care Act) to encourage small employers to offer health insurance coverage to their employees. A small employer is eligible for the credit if it has fewer than 25 full-time employees (FTEs); the average annual wages of employees are less than $50,000 (adjusted for inflation after 2013), and the employer pays at least 50 percent of the cost of premiums. The Code Sec. 45R credit phases-out for employers if the number of FTEs exceeds 10, or if the average annual wages for FTEs exceed $25,000 (adjusted for inflation after 2013). The phaseout of the credit operates in such a way that an employer with exactly 25 FTEs, or with average annual wages exactly equal to $50,000 (adjusted for inflation after 2013), is not eligible for the credit.

SHOP Marketplaces

When Congress passed the Affordable Care Act in 2010 there was no requirement that employers obtain insurance through a SHOP Marketplace (because they did not exist). The requirement to offer insurance through a SHOP Marketplace starts after 2013. SHOP Marketplaces are scheduled to open on October 1, 2013, with coverage starting January 1, 2014.

Employees and hours of service

Determining who is an “employee” requires a complex calculation. Critics of the credit have said this complexity has discouraged small employers from taking advantage of the credit. For example, the Affordable Care Act and the regulations exclude certain employees from being counted as FTEs because of their status. These include sole proprietors, partners, and their family members (spouses, children, step-children, parents, and other family members). There are also special rules for seasonal workers, part-time workers and leased employees.

Employers must also calculate how many hours service each employee performs. Hours of service include vacation, holiday, illness, incapacity (including disability), layoff, jury duty, military duty, or leave of absence, but hours in excess of 2,080 for a single employer are excluded. The IRS allows employers to calculate hours of service using any of three methods: actual hours worked; days-worked equivalency; or weeks-worked equivalency.

Let’s look at an example from the IRS:

ABC Co. pays five employees wages for 2,080 hours each, three employees wages for 1,040 hours each, and one employee wages for 2,300 hours. The employer uses the actual hours worked method to calculate hours of service. The employer’s FTEs would be calculated as follows:

10,400 hours for the five employees paid for 2,080 hours (5 x 2,080)
3,120 hours for the three employees paid for 1,040 hours (3 x 1,040)
2,080 hours for the one employee paid for 2,300 hours (lesser of 2,300 and 2,080)

The total hours counted is 15,600 hours. The employer has seven FTEs (15,600 divided by 2,080 = 7.5, rounded to the next lowest whole number).

Maximum credit

For tax years beginning during or after 2014, the maximum Code Sec. 45R credit is 50 percent. The maximum credit for tax-exempt employers for tax years beginning during or after 2014 is 35 percent.  These percentages were lower before 2014 (35 percent for for-profit employers and 25 percent for tax-exempt employers).

The IRS explained in the proposed regulations that an employer may claim the credit for two-consecutive tax years, beginning with the first tax year in or after 2014 in which the eligible small employer attaches a Form 8941, Credit for Small Employer Health Insurance Premiums, to its income tax return, or in the case of a tax-exempt eligible small employer, attaches a Form 8941 to the Form 990-T, Exempt Organization Business Income Tax Return.

Transition rules

Through the proposed regulations, the IRS has provided employers some relief pending the transition into the 2014 tax year. For example, an eligible small employer does not need to switch plans mid-year to comply with the requirement that an employer offer coverage to its employees through a SHOP Exchange. An employer that has a plan year that begins after the start of its tax year may count premiums paid for the entire 2014 taxable year if the employer begins offering coverage through a SHOP Exchange on the first day of the 2014 health plan year; and the employer offers coverage during the period before the first day of the 2014 health plan year that would have qualified the employer for the credit under the rules applicable to years before 2014.

Reliance regulations

The proposed regs won’t be officially effective until finalized. Taxpayers, however, may rely on the proposed regs for tax years beginning after December 31, 2013, and before December 31, 2014. If future guidance is more restrictive, the IRS explained that future guidance would be applied without retroactive effect and employers will be given time to come into compliance.

If you have any questions about the Code Sec. 45R credit, please contact our office at (908) 725-4414.

Congress returns to work with busy tax agenda

After a five-week break, Congress has returned to work with a full agenda. Proponents of comprehensive tax reform are hoping to build momentum for passage of a bill before year-end. However, before taking up tax reform, Congress has some immediate issues to address, including sequestration for fiscal year (FY) 2014, the debt ceiling, expiring tax extenders, the IRS’s operations, including the confirmation of a new Commissioner of Internal Revenue, and more.


Unless changed by Congress, automatic spending reductions are scheduled to take affect for the government’s FY 2014, effective October 1, 2013. The Budget Control Act of 2011 generally requires that $109 billion in spending, divided equally between defense and nondefense spending, must be reduced in FY 2014. The across-the-board spending cuts will be similar to the ones in effect for FY 2013, which resulted in furlough days for IRS and other federal employees, reductions in certain nonrefundable tax credits and more.

Some federal spending is exempt from sequestration. Most notably are Social Security and veterans’ benefits. Payments to individuals in the form of refundable tax credits are also exempt. This means that taxpayers will not see any reduction in the refundable portion of the child tax credit, the earned income credit and other credits. The Code Sec. 36B health insurance premium assistance tax credit is also exempt from sequestration. However, certain refundable credits available to businesses are subject to sequestration. So far, the IRS has announced reductions in the Code Sec. 45R small employer health insurance credit and the corporate AMT credit because of sequestration.

President Obama has proposed to replace the FY 2014 sequester with a new round of revenue raisers. The President has called on Congress to tax carried interest as ordinary income, repeal the last-in, first-out (LIFO) method of accounting, and reduce certain tax deductions and exclusions for higher income individuals. While the President’s proposals have gained support in the Democratic-controlled Senate, they have a very slim chance of passage in the GOP-controlled House. To win some GOP support, the President has proposed to reduce the corporate tax rate in exchange for increased spending on job creation. Reduced revenue from a cut in the corporate tax would be offset by repeal of unspecified business tax incentives.

Debt ceiling

House Speaker John Boehner, R-Ohio, has repeatedly said that the GOP will not vote to increase the nation’s debt ceiling without more spending cuts. President Obama, on the other hand, has said that he will not negotiate over the debt limit like he did in 2011, which ultimately lead to passage of the Budget Control Act. At this time, the two sides seem far apart but reportedly there have been behind-the-scenes discussions between administration officials and some Republican lawmakers. Unlike past years, the federal deficit is projected to shrink this year because of increasing revenues which could make some lawmakers more receptive to raising the debt ceiling. Some tax measures, such as the tax extenders, could be linked to an increase in the debt ceiling.

Tax extenders

Many popular but temporary tax incentives – affecting individuals and businesses – are scheduled to expire after 2013. They include the state and local sales tax deduction, the higher education tuition deduction, transit benefits parity, the research tax credit, enhanced small business expensing, and more. Supporters of tax reform (discussed in more detail below) want to make the extenders part of a comprehensive tax reform bill. Some extenders, which have yet to be identified, would be allowed to expire; others would be made permanent. More likely, Congress will decide the fate of the extenders in a year-end bill, as it has done frequently in the past.

Tax reform

Two lawmakers have taken on leadership roles in tax reform: Rep. Dave Camp, R-Mich., chair of the House Ways and Means Committee, and Sen. Max Baucus, D-Montana, chair of the Senate Finance Committee. Both lawmakers spent the summer drumming up support for tax reform, but it is unclear how many of their colleagues share their enthusiasm. House Speaker Boehner and his Senate counterpart, Majority Leader Harry Reid, D-Nevada, have expressed, at best, lukewarm support for comprehensive tax reform in 2013.

Of the two lawmakers, Camp seems more prepared to bring tax reform bill before his committee this fall. Eleven working groups comprised of members of the Ways and Means Committee have been discussing tax reform for many months. The Ways and Means Committee has issued discussion drafts on business tax reform, international taxation, accounting methods, and more. The Senate Finance Committee has also released discussion drafts on tax reform but they are not as detailed as the drafts prepared Ways and Means Committee. In August, Baucus said that the Ways and Means Committee is further ahead in drafting tax reform legislation that the Senate Finance Committee.

IRS operations

Since May, Daniel Werfel has been temporarily leading the IRS. Werfel has been a frequent witness at Congressional hearings looking into the agency’s treatment of conservative groups and others seeking tax-exempt status. Werfel has also been championing increased funding for the IRS.

President Obama has nominated John Koskinen to be the next Commissioner of Internal Revenue. Koskinen previously served as the nonexecutive chair of the Federal Home Loan Mortgage Corporation. The Senate Finance Committee is expected to take up Koskinen’s nomination this fall. Lawmakers are certain to ask Koskinen how he intends to oversee the agency and what reforms he may make.

Affordable Care Act

One huge divide between the White House and the GOP is the Affordable Care Act, including its many tax provisions. Before leaving for the August recess, the House voted to repeal the Affordable Care Act. Knowing that the Senate will not take up the House bill, some GOP lawmakers have turned to another tactic: defunding the Affordable Care Act.

On October 1, health insurance marketplaces for individuals are scheduled to open. Small employers (generally employers with fewer than 50 workers) can purchase insurance through the Small Business Health Options Program (SHOP), which also opens October 1. Coverage will begin January 1, 2014.

If you have any questions about Congress’ fall agenda, please contact our office at (908) 725-4414.


First steps for 2013 year-end tax planning

Even though the calendar still says summer, it’s not too early to be thinking about year-end tax planning. In fact, year-end tax planning has become around-the-year tax planning because of tax legislation (or the lack of tax legislation), new IRS rules and regulations and personal and business considerations. Looking ahead to year-end 2013, there are many tax planning strategies to explore and evaluate.

ATRA brings some certainty

Unlike last year at this time, there is some more certainty to tax planning because of passage of the American Taxpayer Relief Act of 2012 (ATRA). ATRA permanently extended the Bush-era individual income tax rate cuts for most taxpayers but also put in place a top income tax bracket of 39 percent for higher-income taxpayers. In 2012, taxpayers were unsure what the individual rate brackets would be for 2013, which complicated year-end planning. Now, we know the brackets are 10, 15, 25, 28, 33, 35, and 39.6 percent for 2013 and beyond. ATRA also ended uncertainty over the alternative minimum tax (AMT). Previously, Congress had to pass so-called “AMT patches” to prevent the AMT from encroaching on middle income taxpayers. ATRA patches the AMT for 2013 and subsequent years by increasing the exemption amounts and allowing nonrefundable personal credits to the full amount of the individual’s regular tax and AMT. In the estate tax area, ATRA brings some certainty to tax planning. ATRA set the maximum estate tax rate at 40 percent, provided for portability and more.

Many expiring provisions

ATRA extended – but did not make permanent – countless tax incentives. They range from incentives targeted to individuals, such as the state and local sales tax deduction, the teachers’ classroom expense deduction and the higher education tuition deduction, to incentives for business, including the research tax credit, bonus depreciation, and enhanced small business expensing. In 2012, for the first time in many years, Congress did not extend all of the expiring incentives (leaving, for example, the District of Columbia homebuyer credit to expire). It is possible that Congress could prune the extenders even more in 2013. President Obama has proposed to eliminate many fossil fuel extenders. If Congress keeps to past practice, the fate of the extenders will not be decided until late in 2013, or in early 2014. Late tax legislation means that the IRS will likely have to delay the start of the 2014 filing season. Our office will keep you posted of developments.

Traditional year-end considerations

Traditional year-end planning considerations should not be overlooked. These include changes in filing status due to marriage, death or divorce. Keep in mind also the Supreme Court’s decision to strike down Section 3 of the Defense of Marriage Act (DOMA), which presumably will open the door to married same-sex couples being able to file as married filing jointly (much-anticipated IRS guidance has yet to be issued). Gift-giving is another valuable year-end tool. For 2013, the annual gift tax exclusion is $14,000 ($28,000 for married couples making split-gifts). Qualified individuals can also make a gift to charity from IRA funds, but only through the end of 2013. If possible, taxpayers may want to project what will be the amount of their 2013 itemized deductions. For some taxpayers, medical expenses may make up a large percentage of their itemized deductions. The floor on deductible medical expenses is 10 percent of adjusted gross income in 2013 (7.5 percent for senior citizens). Others should compare the state and local sales tax deduction (especially taxpayers who have made or may make big ticket purchases in 2013) with the state and local income tax deduction to maximize their savings. Don’t forget the education tax incentives. For 2013, the American Opportunity Tax Credit and the Lifetime Learning credit, along with others, are available to qualified taxpayers. Timing the recognition of capital gains and losses is important, to maximize offsetting short-term gains taxed at ordinary income tax rates, with short-term losses. In 2012, the maximum tax rate on qualified capital gains (and dividends) was 15 percent (with some taxpayers qualifying for a zero percent rate). However, ATRA raises the top rate to 20 percent for certain higher-income taxpayers whose income exceeds the thresholds for the 39.6 percent income tax rate.

Additional business strategies

Along with planning for the extenders and the Affordable Care Act (discussed below) businesses also should be aware of pending revisions to regulations on the capitalization of tangibles (called “repair regs” for short). The rules go far beyond “repairs.” One important ingredient to planning under the repair regs is the provision for de minimis expensing. This rule can be helpful if the tax year in which the cost of qualified materials and supplies is paid or incurred before the tax year of use or consumption. The window for bonus depreciation is also closing, unless extended by Congress. ATRA extended 50 percent bonus depreciation through 2013 (some transportation and longer period production property may be eligible for 50 percent bonus depreciation through 2014). Qualified property must be placed in service before January 1, 2014 (or January 1, 2015 if applicable). Employers that want to take advantage of the Work Opportunity Tax Credit (WOTC), with its enhanced benefits for hiring veterans, need to act before January 1, 2013. The WOTC is a popular incentive and is likely to be extended but the provisions for veterans could be changed.

Affordable Care Act

January 1, 2014 is the start date for many provisions of the Affordable Care Act. The Obama administration has postponed the so-called employer mandate until 2015 but other requirements – including the individual mandate – continue to apply. For example, the Affordable Care Act limits annual salary reduction contributions to a health flexible spending arrangement under a cafeteria plan to $2,500 (adjusted for inflation after 2013). The IRS is also asking that employers voluntarily comply with information reporting requirements for health insurance coverage for 2014. Please contact our office for more details about the Affordable Care Act’s requirements for 2014 and beyond.

NII surtax

On January 1, 2013, the new 3.8 percent net investment income (NII) surtax took effect. The surtax, which was passed by Congress to help fund health care reform, is imposed on the net investment income of higher-income individuals, estates and trusts that exceeds certain thresholds. Generally, the surtax applies to passive income but can also reach capital gains from the disposition of property. Some taxpayers may have sold property or changed their source of income in 2012 to avoid the surtax. Now that the surtax is effective, new strategies should be considered to minimize, if possible, the surtax. There is also a new 0.9 percent Additional Medicare Tax that reaches higher income individuals. We have highlighted a lot of year-end planning considerations. Please contact our office to discuss year-end planning tailored for you.