Vernoia, Enterline + Brewer, CPA LLC

Archive for October, 2013

FAQ: What are the tax rates on capital gains and dividends?

Despite the passage of the American Tax Relief Act of 2012 – which its supporters argued would bring greater certainty to tax planning – many taxpayers have questions about the tax rates on qualified dividends and capital gains.

Background

Before ATRA, the maximum tax rate on net capital gains and qualified dividends was 15 percent for taxpayers in the 25, 28, 33, or 35 percent individual income tax brackets (the 35 percent rate was the highest individual tax bracket before ATRA). For 2008 through 2012, taxpayers in the 10 and 15 percent individual income tax brackets enjoyed a zero percent tax rate on net capital gains and qualified dividends. Generally, the 15 and zero percent rates applied to long-term capital gains (resulting from the sale of an asset held for longer than one year) and qualified dividends (such as dividends received from a domestic corporation and certain foreign corporations).

ATRA’s rates

Under ATRA, the 15 percent rate on net capital gains and qualified dividends is made permanent for taxpayers in the 25, 28, 33, or 35 percent individual income tax brackets. This treatment applies for 2013 and all subsequent years unless modified by Congress in the future. ATRA also made permanent the zero percent tax rate on net capital gains and qualified dividends for taxpayers in the 10 and 15 percent income tax brackets. This treatment applies for 2013 and all subsequent years unless modified by Congress.

Additionally, ATRA created a 20 percent tax rate on net capital gains and qualified dividends intended to apply to higher income taxpayers. The 20 percent tax rate applies to qualified capital gains and dividends of taxpayers subject to the revived 39.6 percent income tax bracket. Taxpayers are subject to the 39.6 percent income tax bracket to the extent their taxable income exceeds certain thresholds: $450,000 for married couples filing joint returns and surviving spouses, $425,000 for heads of households, $400,000 for single filers, and $225,000 for married couples filing separate returns. These threshold amounts are projected to be slightly higher in 2014 as indexed for inflation.

Collectibles and unrecaptured Code Sec. 1250 gain

The Tax Code has special tax rates for collectibles and unrecaptured Code. Sec. 1250 gain. These tax rates were not changed by ATRA or other legislation. A 28 percent tax rate applies to collectibles, and a 25 percent tax rate applies to unrecaptured Code Sec. 1250 gain.

Short-term capital gains

The tax rates are significantly different for short-term capital gains than for long-term capital gains. Short-term capital gains are taxed at ordinary income tax rates. This means that the tax rate on short-term capital gains can range from 10 percent to 39.6 percent, depending on the taxpayer’s situation. Income generated from non-capital assets are also subject to these rates.

Net investment income surtax

Unrelated to ATRA’s changes is a new 3.8 percent surtax imposed by the Patient Protection and Affordable Care Act (PPACA) on individuals, estates and trusts that have certain investment income above threshold amounts including $250,000 for married couples filing jointly and $200,000 for single filers. These amounts are not subject to an annual adjustment for inflation. The 3.8 percent surtax took effect January 1, 2013 and therefore will be reflected on 2013 returns filed in 2014.

Timing the recognition of capital gain and offsetting losses when possible can frequently lower overall tax liability. Year-end tax planning can be a particularly advantageous in this regard. If you have any questions about the capital gains and dividends tax rates, please contact our office at (908) 725-4414.

How do I . . . Claim bonus depreciation in 2013?

Bonus depreciation will expire for most taxpayers at the end of 2013 unless Congress extends the provision. A 50-percent bonus depreciation deduction (the “special first-year depreciation allowance”) is allowed for the first year that qualifying property is placed in service. Bonus depreciation is available for property acquired after December 31, 2007 and acquired and placed in service only before January 1, 2014 (the “applicable period”).

The 50-percent rate is also available for property acquired pursuant to a binding written contract entered into during the applicable period. Self-constructed property for the taxpayer’s own use qualifies for bonus depreciation if the taxpayer begins manufacturing, constructing or producing the property during the applicable period. In addition, the 50-percent rate is extended one year, to property acquired and placed in service before January 1, 2015, for property with a longer production period and for aircraft. Unlike the Code Sec. 179 expensing allowance, there is no limit on the overall amount of bonus depreciation that may be claimed.

The bonus depreciation rate was 100 percent for qualified property acquired after September 8, 2010 and before January 1, 2012, and placed in service before January 1, 2012. A special election is available under Rev. Proc. 2011-26 for taxpayers that want to claim 50-percent bonus depreciation instead of the 100-percent rate available in the latter part of 2010 and in 2011.

Qualifying property

Qualifying property is property depreciable under MACRS (the Modified Accelerated Cost Recovery System) that has a recovery period of 20 years or less, or is MACRS water utility property, computer software depreciable over three years, or qualified leasehold improvement property. The property must be new property, and its original use must start with the taxpayer during the applicable period. Property is acquired when the taxpayer takes possession or control of the property and has the risk of loss. Property is placed in service when it is in a condition or state of readiness and availability for a specifically assigned function in a trade or business, or for the production of income.

Election out

A taxpayer must claim bonus depreciation unless the taxpayer elects not to take any additional first year depreciation. This “election out” applies to all property in the class or classes for which the election is made, and that is placed in service for the tax year of the election. The election out may be revoked only with the IRS’s consent.

The election must be made by the due date (including extensions) of the tax return for the year in which the property is placed in service. Form 4562 provides instructions for making the election. The taxpayer must attach a statement to the return that indicates the property class for which the election is being made.

Projected 2014 inflation-adjusted tax amounts show modest increases

In 2014, individual taxpayers will receive some relief by way of the mandatory upward inflation-adjustments called for under the Tax Code, according to CCH, a part of Wolters Kluwer. CCH has released projected income ranges for each of the 2014 tax brackets as well as a growing number of other inflation-sensitive tax figures, such as the personal exemption and the standard deduction.

When there is an upward adjustment for inflation, the indexing of brackets can lower tax bills by including more of taxpayers’ incomes in lower brackets-in the existing 15-percent rather than the existing 25-percent bracket, for example. The formula used in indexing showed relatively low inflation throughout 2013. Nevertheless, many 2014 figures therefore have increased.

In addition, tax planners will have more certainty moving into 2014. By enacting the American Taxpayer Relief Act of 2012 (ATRA) at the beginning of 2013, Congress permanently extended several of the formerly temporary provisions whose fate often hinged on end-of-the-year legislation. This ensures that in 2014 taxpayers will know for certain that the Alternative Minimum Tax exemptions and other important figures will be adjusted for inflation.

Tax Rates

The current tax rates, as enacted under ATRA, are: 10, 15, 25, 33, 35, and 39.6-percent. CCH projects that inflation during 2013 will raise the 2014 rate brackets for individuals as follows:

Joint returns. For married taxpayers filing jointly and surviving spouses, the maximum taxable income for the 10% bracket is $18,150 (up from $17,850 in 2013); for the 15% tax bracket $73,800 (up from $72,500 in 2013); for the 25% tax bracket $148,850 (up from $146,400 in 2013); for the 28% tax bracket $226,850 (up from $223,050 in 2013); for the 33% tax bracket $405,100 (up from $398,350 in 2013); and for the 35% tax bracket $457,600 (up from $450,000 in 2013). Above the 35% threshold, taxpayers will fall within the top 39.6% tax bracket.

Heads of Household. For heads of household, the maximum taxable income for the 10% bracket is $12,950 (up from $12,750 in 2013); for the 15% tax bracket $49,400 (up from $48,600 in 2013); for the 25% tax bracket $127,550 (up from $125,450 in 2013); for the 28% tax bracket $206,600 (up from $203,150 in 2013); for the 33% tax bracket $405,100 (up from $398,350 in 2013); and for the 35% tax bracket $432,200 (up from $425,000 in 2013). Above the 35% threshold, taxpayers will fall within the top 39.6% tax bracket.

Single filers. For unmarried single filers who are not heads of household or surviving spouses, the maximum taxable income for the 10% bracket is $9,075 (up from $8,925 in 2013); for the 15% tax bracket $36,900 (up from $36,250 in 2013); for the 25% tax bracket $89,350 (up from $87,850 in 2013); for the 28% tax bracket $186,350 (up from $183,250 in 2013); for the 33% tax bracket $405,100 (up from $398,350 in 2013); and for the 35% tax bracket $406,750 (up from $400,000 in 2013). Above the 35% threshold, taxpayers will fall within the top 39.6% tax bracket.

Married filing separately. For married taxpayers filing separately, the maximum taxable income for the 10% bracket is $9,075 (up from $8,925 in 2013); for the 15% tax bracket $36,900 (up from $36,250 in 2013); for the 25% tax bracket $74,425 (up from $73,200 in 2013); for the 28% tax bracket $113,425 (up from $111,525 in 2013); for the 33% tax bracket $202,550 (up from $199,175 in 2013); and for the 35% tax bracket $228,800 (up from $225,000 in 2013). Above the 35% threshold, taxpayers will fall within the top 39.6% tax bracket.

Estates and trusts. For estates and trusts, the maximum taxable income for the 15% tax bracket is $2,500 (up from $2,450 in 2013); for the 25% tax bracket $5,800 (up from $5,700 in 2013); for the 28% tax bracket $8,900 (up from $8,750 in 2013); and for the 33% tax bracket $12,150 (up from $11,950 in 2013). Above the 33% threshold, taxpayers will fall within the top 39.6% tax bracket. There is no 35% tax bracket for estates and trusts.

Standard deduction

The 2014 standard deduction will be $6,200 for single taxpayers; $12,400 for married joint filers; $9,100 for heads of household; and $6,200 for married separate filers.

2014 personal exemption

The 2014 personal exemption is projected to increase by $50, to $3,950, up from $3,900 in 2013. The phase out of the personal exemption for higher income taxpayers will begin after taxpayers pass the same income thresholds set forth for the limitation on itemized deductions.

Limitation on Itemized Deductions

For higher income taxpayers who itemize their deductions, there is a limitation on the amount of itemized deductions that can claim. This limitation was not in effect for several years, but was reinstated by ATRA for tax years beginning on or after January 1, 2013. The limitation will be imposed at income above the following levels:

For married couples filing joint returns or surviving spouses, the income threshold will be $305,050, up from $300,000 in 2013. For heads of household, the threshold will be $279,650 in 2014, up from $275,000 in 2013. For single taxpayers, the threshold will be $254,200, up from $250,000 in 2013. For married taxpayers filing separate returns, the 2014 threshold will be $152,525, up from $150,000 in 2013.

AMT Exemptions

ATRA provided for the annual inflation adjustment of the exemption from AMT income. Previously, this inflation adjustment had to be enacted by Congress each year. CCH projects that, for 2014, the AMT exemption for married joint filers and surviving spouses will be $82,100 (up from $80,800 in 2013). For heads of household and unmarried single filers, the exemption will be $52,800 (up from $51,900 in 2013).

If you have any questions about these or other inflation adjustments, please contact our office at (908) 725-4414.

IRS releases guidance for married same-sex couples

The U.S. Supreme Court’s decision in June to strike down Section 3 of the Defense of Marriage Act (DOMA) (E.S. Windsor, 2013-2 ustc ¶50,400) generated many questions about federal taxes and same-sex couples. The IRS has responded with a general rule recognizing same-sex marriages nationwide. The agency also promised that more guidance will be released before the start of the 2014 filing season.

Place of celebration approach

Section 3 of DOMA prevented the IRS (and all federal agencies) from recognizing same-sex married couples as married. After the Supreme Court struck down Section 3 of DOMA, the IRS had an important decision to make. The IRS could recognize all same-sex marriages regardless of where the couple resided. Alternatively, the IRS could only recognize the marriages of couples who reside in states that recognize same-sex marriage.

The IRS chose the first approach, which is known as “place of celebration” approach. All legally married same-sex couples will be treated as married for all federal tax purposes, including income and gift and estate taxes, regardless of whether a couple resides in a jurisdiction that recognizes same-sex marriage or in a jurisdiction that does not recognize same-sex marriage. This means that a couple who marry in a state (or other jurisdiction) that recognizes same-sex marriage and subsequently move to a state that does not recognize same-sex marriage will continue to be treated as married for all federal tax purposes.

The IRS had an important historical precedent that lead to its choosing place of celebration over place of residence. The IRS has taken a place of celebration approach to common law marriages for over 50 years.

Tax returns

For 2013 returns filed in 2014, legally married same-sex couples must file as married filing jointly or married filing separately. The rules for 2012 and prior years are not as simple.

The IRS imposed a deadline of September 16, 2013 for married same-sex couples, who had yet to file an original return for 2012, to file as single or as married. For 2011 and earlier, same-sex spouses who filed their tax returns timely may choose (but are not required) to amend their federal tax return filing status. They may amend their prior-year returns using either married filing separately or jointly filing status, provided the period of limitations for amending the return has not expired. If you have any questions about filing an amended return, please contact our office.

Employee benefits

Because of DOMA, taxpayers may have paid taxes on the fair market value of employer-provided health care coverage for their same-sex spouse. The IRS will allow the employee to file an amended return for open tax years reflecting his or her status as a married individual to recover federal income tax paid on the value of health coverage of the employee’s spouse. The IRS also instructed certain sponsors of some employee benefit plans to treat same-sex spouses as spouses.

Employment taxes

The IRS has provided two optional alternative special administrative procedures for employers to use to correct overpayments of employment taxes. Under the first alternative, employers may use the fourth quarter 2013 Form 941, Employer’s Quarterly Federal Tax Return, to correct these overpayments of employment taxes for the first three quarters of 2013. Under the second alternative, employers may file one Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund, for the fourth quarter of 2013 to correct these overpayments of FICA taxes for all quarters of 2013. Please contact our office for more details about these optional procedures.

Domestic partners

There is one very important distinction that the IRS has made in its guidance for same-sex couples. The IRS is not recognizing registered domestic partners, individuals in a civil union, or similar relationships as married. Registered domestic partners may not file as married filing jointly or married filing separately because the individuals are not married or spouses for federal tax purposes

Looking ahead

The IRS will likely begin accepting 2013 returns for processing in mid- to late January 2014. Some same-sex couples may find their filing more complicated despite the demise of DOMA. States that do not recognize same-sex marriage will presumably not allow these couples to file their state returns (if required) as married. The IRS is also expected to issue more guidance on particular areas of the tax law, such as estate and gift taxes, retirement plans and more. Our office will keep you posted of developments.

Please contact our office at (908) 725-4414 if you have any questions about the IRS’s guidance for same-sex couples.

IRS; Final “repair” regulations

The IRS has issued much-anticipated final “repair” regulations that provide guidance on the treatment of costs to acquire, produce or improve tangible property. These regulations take effect January 1, 2014. They affect virtually any business with tangible assets. The IRS has estimated that about 4 million businesses must comply.

At a length of over 200 pages, the regulations remain complex. Taxpayers will need to devote significant time and effort to study these regulations and to address their impact on their tax accounting. Taxpayers must decide whether they can deduct costs as repairs and maintenance or must capitalize the costs and recover their costs over a period of years. Every business, especially those with significant fixed assets, must develop an understanding of the regulations and their requirements.

Effective dates, decisions and opportunities

The final regulations retain the basic structure of the temporary and proposed regulations issued in December 2011 (the 2011 regulations). The IRS is not expected to delay these effective dates, since taxpayers were informed of the impending changes in many of the rules almost two years ago. Moreover, taxpayers will have the decision of whether to apply the regulations (either the temporary or the final) to the 2012 or 2013 tax years.

The IRS must provide additional guidance for taxpayers to change their methods of accounting to elect to apply either set of regulations retroactively and to comply with the 2014 effective date. Some accounting method changes will require taxpayers to make adjustments under Code Sec. 481(a), in effect, applying the regulations to past years and calculating the impact on income.

The final regulations make significant changes that can benefit most taxpayers if applied correctly. The changes include new and revised safe harbors, as well as new relief provisions for small business. The regulations will provide simplification and reduce controversy by allowing taxpayers to follow their financial accounting (“book”) policies in some areas.

The IRS did not finalize every portion of the 2011 regulations. To address some problems with the temporary regulations on the disposition of depreciable property, the IRS issued new proposed regulations that ease the requirements for taxpayers to deduct the cost of building components that they replace.

Significant provisions in the final regulations include the following:

Materials and supplies – The threshold for deducting materials and supplies was increased from $100 to $200 and generally applies to items expected to be consumed in 12 months or less, or that have an economically useful life of 12 months or less.

De minimis safe harbor – The final regulations eliminate a controversial ceiling on the use of this safe harbor. Taxpayers with applicable financial statements can apply the safe harbor to an item that is $5,000 or less. The regulations extend the safe harbor to taxpayers without a financial statement, but only for property that costs $500 or less. Taxpayers must have written book policies in place at the beginning of the year to apply the safe harbor.

Routine maintenance and improvements – The final regulations retain controversial unit of property rules that apply the rules for real property to eight separate building systems. However, the rules do extend the routine maintenance safe harbor to real property and provide a new safe harbor for small taxpayers. The safe harbor for real property limits the period for recurring maintenance to 10 years, which many practitioners believe is too short.

Capitalization election – The final regulations allow taxpayers to capitalize repair and maintenance costs if these costs are capitalized for financial accounting purposes. This provides significant simplification over the temporary regulations, although the tax impact is contrary to what taxpayers normally want.

If you have any questions regarding the compliance obligations that your business now must face, and the opportunities that many of these new rules present, please do not hesitate to call this office at (908) 725-4414.