IRA--Deceased Spouse

If one member of a married couple dies and leaves an IRA to the other, there is a potential pitfall to avoid if the surviving spouse is under 59 1/2 years old. If the surviving spouse takes distributions from the IRA, there are no penalties for early distribution, because death is an exception. However, if the surviving spouse rolls it over into his or her own IRA or into a new IRA, then the death exception no longer applies, and penalties will be assessed on distributions. The only thing the surviving spouse can do in that situation to avoid penalties is to wait until he or she becomes 59 1/2, or until a situation arises in which some other exception applies.

Some of the other exceptions are:
Disability
Medical (subject to severe limits)
Distributions to unemployed individuals for health insurance premiums
Higher education expenses
First home buyer (up to $10,000)
Distributions to reservists while on active duty for at least 180 days.

Qualified Charitable Distribution

Many people are familiar with or have used the Qualified Charitable Distribution (QCD). It enables a person over 70 1/2 years old to make a direct payment to a charity from his or her IRA with no tax consequences. Without the QCD feature, if you take money out of an IRA and donate it to a charity, you have to pay tax on the withdrawal, but you are not guaranteed to get a deduction for the full amount of the donation. This is especially true for someone who does not usually itemize deductions. Various other factors can enter in to raise your tax despite the fact that all the money went directly to a charity. With the QCD, if the money is paid directly out to the charity by the IRA and never touches the taxpayer's hands, there is no effect on income tax.

The QCD has been in effect for a few years, but it is scheduled to expire at the end of this year. It was supposed to expire last year, but Congress renewed it at the last minute, and gave people till the end of January, 2011, to do a QCD for 2010. No one knows (probably not even Congress at the moment) if it will be renewed again.

IRS Budget Cuts

Kiplinger reports that the IRS's budget will be cut back for 2012. The only question is by how much. So far, Congress has deep cuts in mind, but that could change by the time the budget is finalized. It could mean even longer waits on hold when we try to call them. It could possibly mean that the IRS has less resources for collections. The last we heard about that, the plan had been to put more resources into collection, but apparently budget realities could interfere with that. From the government's point of view, putting more resources into collections would be cost-effective, as it would bring in more money than than was spent on it. But don't tell them that. (Sssshhhh!)

Social Security

Social Security recipients will get a 3.6% raise in 2012. They went a couple of years without a raise, because there supposedly was no inflation during those years.

A frequent question is, what happens if I retire before the full retirement age? People can retire at age 62 if they want, but their monthly checks will be less, and they will have limits on the amount of income they can earn before their benefits are reduced. After full retirement age (which is 66 for people retiring in 2012), you can earn as much as you want without any limitations on your SS benefits.

The earnings limits for people under 66 apply only to "earned" income, not things like rents received, interest, dividends, etc.

In 2012, the amount a person under 66 can earn without benefit cuts will be $14,640.

IRS Computers

Their computers are back up. Sorry to get your hopes up.

IRS computers crash

We called the IRS for a routine representation matter on Friday, Sept 9, and were told that their nationwide computer network had crashed at about 8:00 that morning. They took our name and number and said that someone would call us back within 30 days. We assume that the network will be back up in less than 30 days. We will keep you posted.

Estate tax, more

The Federal estate tax is still in danger of reverting after 2012 to a $1,000,000 exemption and a 55% tax rate. Congress has not made the current law permanent. The odds are they will do something before 2012 is over, but it would be nice is they would commit to something for the long term.

Foreign Accounts

The IRS's amnesty program for people with undeclared foreign accounts ends Aug 31. It allows affected taxpayers to pay taxes owed plus a penalty and avoid criminal prosecution for tax evasion. Meanwhile their investigation of foreign banks continues with Credit Suisse, a large Swiss bank.

Gift tax basics

The gift tax exemption for 2011 and 2012 is $5,000,000. This is a lifetime exclusion. That means that a person can give up to that amount in his/her lifetime and not owe any gift tax.

A person can also give up to $13,000 each per year to any number of persons without having to count it towards the $5,000,000 and without the need to report it in any way.

If a person gives over $13,000 in a year to any one person, the giver must file a gift tax return. Though no tax is due as long as the lifetime total is under $5M, it officially reduces that $5M, which runs like a declining balance during the person's lifetime of giving.

When the person dies, the remaining balance is used to calculate the person's estate tax exemption.

Because Congress can't make up its mind about these things, the $5,000,000 exemption is scheduled to be reduced to $1,000,000 in 2013. (However, the estate tax exemption will still be $5M.) If that happens, anyone who has gone over $1,000,000 in reportable gifts by then, or who goes over it in 2013 or thereafter, will have to pay a gift tax on any subsequent gifts.

Congress may or may not act to preserve the $5,000,000 exemption. Everyone thought they would do something to avert the expiration of the estate tax for 2010, but the year was virtually over before they did anything.

You should also know that there are certain situations in which the gift tax exemption does not apply.

The top gift tax rate is currently the same as the top estate tax rate: 35%.

AMT Reform

A group called ReformAMT is campaigning to eliminate the Alternative Minimum Tax on Incentive Stock Options. There is generally no regular tax when a person exercises ISO's, but the AMT on it can sometimes be substantial. People who are whacked with this tax don't like it, especially since it often comes as quite a surprise. Also, the transaction on which they are being taxed did not put any money in their pocket. (So how are they supposed to pay the tax??) Go to www.reformamt.org to find out what they are up to.

Mileage rates

The standard mileage rate for business vehicle use is 55.5 cents for the July-Dec, 2011 period. For Jan-June, 2011, the rate was 51 cents per mile.

Other rate changes:
Medical miles: Jan-June = 19 cents; July-Dec = 23.5 cents
Moving expense miles: same as Medical miles

The rate for Charity miles remains 14 cent per mile.

Earned Income Credit

The IRS has been concerned for some time with abuse of the Earned Income Credit. They have adopted a number of rules and requirements to combat that abuse. Tax preparers will probably have more hoops to jump through in coming years to substantiate the validity of the credit claimed. Some checklists exist which have been used voluntarily, but they may become required forms. No exact timetable has been given for such changes.

Gift tax crackdown

As we reported in February, the IRS is trying to track down people who have failed to file gift tax returns. Recently they tried to get the state of California to give them records on people who transfer real estate to family members for no money or very little money. State attorneys argued in court that the records exist at the county level, not the state level, and that therefore the state could not do it. The court agreed. The IRS was directed to seek the records at the county level. There are 58 counties in California. The IRS has not said yet what it intends to do. A couple of possibilities are: (a) Proceed in contacting the counties, or (b) Move on to another state that might be easier to deal with. Massachusetts in recent years has moved many county functions to the state level, so we should not rule out the IRS snooping around here.

Buying business assets

Machinery and equipment purchased in 2011 can be directly expensed (rather than depreciated) up to a value of $500,000. (Unless you buy more than $2,000,000 worth of such items.) In addition to machinery and equipment, this year you can also write off most types of leasehold improvements, restaurant property and retail improvements. These deductions come under the heading of what is known as "Section 179." The assets can be new or used.

These big breaks are not available for cars and light trucks under Section 179, but there is another depreciation provision known simply as bonus depreciation. This provision allows a 100% deduction for NEW assets purchased in 2011. (Remember, it has to be new, not used.) Also, it must have a recovery period of more than 20 years (so real estate is not allowed), and it must not be "listed property" (vehicles etc.) used less than 50% for business.

The 100% falls to 50% in 2012.

For Massachusetts taxes, the bonus depreciation deduction is not recognized, so you could end up with different depreciation calculations on the Federal and state returns. It could result in much higher taxable income for Massachusetts than for the federal return. Massachusetts does recognize the Section 179 deduction.

There, is that complicated enough? And that's only the simple part.

After tax season

We didn't have much time for blogging during the tax season. We hope to catch up a little now.

What are the prospects for tax reform? If the tax system were overhauled, what might it look like?

One possible outline issued by a government commission envisions three tax rates: 12%, 22% and 28%. There would be no alternative minimum tax, but only two types of itemized deductions would be allowed: mortgage interest and donations. No mortgage interest deduction would be allowed on second homes. Capital gains and dividends would be taxed at the regular tax rate. Municipal bonds would no longer be exempt from tax. Many other tax breaks would be eliminated.

Of course, this is not likely to happen soon, and if and when anything does happen, it will certainly be quite different from the above outline. This just gives an idea of what some of the thinking is. There is a lot of other thinking going on, too, but nothing concrete yet.

One area of concern, however, is the capital gains tax. There is a strong possibility that it will go up. The debate is likely to on for at least a couple of more years. If it begins to look as though passage is immanent, people holding appreciated assets will probably start selling like mad to avoid the coming tax bite.

1099 Never-Mind

The new requirements discussed in my 2/19/11 and 1/10/11 posts have now been repealed, pending the President's signature.

The Residential Energy Credit survived for 2010, and it has been extended in limited form into 2011. However, in 2010 it is limited to $1,500, and if you took the credit in 2009, the amount you took in that year reduces the amount you can take in 2010. For example, if you took a credit of $500 in 2009, your limit for 2010 is $1,000.

The limit in 2011 is only $500, and all the Residential Energy Credits you have taken since 2006 go towards reducing that limit. The credit has also been limited somewhat in the things that it covers, but it will still be good for windows, doors, insulation, certain kinds of roofs, qualified furnaces, etc.

The credit is good for your main home only. It is not for property you rent out to others. Also the home must be located in the United States.

Social Security wage base

People who make more than $106,800 this year will not have to pay Social Security tax on earnings above that amount. 2011 is the third year this wage base has been pegged at $106,800.

The base has risen quite a bit over the years. In the year 2000, it was $76,200. From 1937 to 1950 it was $3,000.

From 1937 to 1949, the Social Security withholding rate on wages was 1%. When Medicare started in 1966, the withholding rate was 0.35%.

The base in 2012 is expected to be $110,100. (This is not official yet.) It is estimated to be $113,100 in 2013, $117,600 in 2014 and $122,700 in 2015.

The tax rate for Social Security withholding from pay checks has been 6.2% since 1990. For 2011 however, it has been lowered to 4.2%. It goes back to 6.2% in 2012.

The Medicare tax of 1.45% has no limit. If you make $1,000,000 this year, 1.45% of it will go to Medicare. That's $14,500. The Social Security tax, since it stops for wages above $106,800, will never go above $4,485.60 (4.2% of 106,800) for anyone in 2011.

And by the way, one of the provisions of the Health Care law that passed last year is that Medicare tax will be charged not only on earned income but also on investment income. However, that is not in effect for 2011.

For every employee who has Social Security and Medicare taxes withheld from his or her pay, the employer must also pay into those funds. For every year but 2011, the employer's share was equal to the employee's share. This year, though the Social Security rate for employees was reduced to 4.2%, the employer's rate remains 6.2%.

The total payroll tax "burden" (as it is called) for these two taxes, in 2010 was:
Employee's Social Security withholding 6.20%
Employer's Social Security share 6.20%
Employee's Medicare withholding 1.45%
Employer's Medicare share 1.45%
Total 15.30%

In 2011 the total is 13.3%, because of the 2% reduction in employee withholding. In 2012 it will return to 15.3%.

Self-employed people must pay the entire amount themselves: 13.3% of earnings this year, and 15.3% every other year. This can be a brutal blow to a self-employed person at tax time.

More on 1099s

Congress is considering repealing the new requirement that 1099s be filed on payments to corporations. They may also repeal the requirement that landlords file 1099s on all their payments for services (as discussed in an earlier post).

Even More 1099's

In 2012, additional 1099 reporting requirements are due to take effect, unless Congress repeals them. They would require that anyone with any business income issue 1099s to any vendor to whom they paid at least $600. Payments for both goods and services would require 1099s. (Under current law, payments for goods are not covered, and the focus is on payments to unincorporated individuals.)

Congress and the President have talked about repealing this new requirement, because nobody likes it. However, because it is projected to generate over $200 billion in tax revenues over the next 10 years, they have to figure out how to plug that budget gap if they repeal it. There is a lot of momentum on the side of repealing it, but it may not be easy.

Unreported gifts

Many people transfer real estate titles to heirs or other family members without filing a gift tax return. The IRS has never checked on this to any great extent, but it is starting to do so now. If the transfer was done for anything less than fair market value, it could trigger the need for a gift tax return. Most people would not owe any actual gift tax, because their gifts are under the tax threshold. However, the law says a gift tax return must be filed. A gift tax return is supposed to be filed if you give any one person more than $13,000 during a calendar year. (The filing threshold was $10,000 several years ago; it has been gradually raised over the past few years to the present threshold of $13,000.)

Obamacare legal setback

A Federal district court judge in Florida ruled that the healthcare reform law is unconstitutional. The Supreme Court will get the final word--in a year or two.

filing delay date

The IRS has specified February 14, 2011, as the date on which it will begin accepting returns with certain characteristics. The most popular of these characteristics is itemized deductions. Most returns without itemized deductions are already being accepted.

Landlords must issue 1099s

Beginning in 2011, landlords must issue 1099s if they pay someone (e.g., a self-employed carpenter or plumber) $600 or more during the year. Previously, landlords were not covered by the 1099 laws.

Some landlords will be exempt if their rental income is very small. The IRS will let us know at a later date (hopefully sometime this year) how much rental income will trigger the 1099 requirement.

Qualified Charitable Distribution

One of the last-minute changes in the new tax law had to do with the option for people over 70 and a half years old to make a charitable donation directly from their IRA without declaring it as income. That provision was supposed to expire as of 12/31/09, but there was some confusion over it during the year, probably because it was almost, but not quite, renewed during the year. Now it has indeed been renewed. And because of the last-minute nature of the renewal, eligible taxpayers have been given the option to make such a distribution in January of 2011 that can be counted as happening in 2010. Contact your IRA administrator.

Tax filing delay

The IRS has announced that it will need some extra time to reprogram their computers in regard to some of the provisions of the new tax law. Therefore returns with certain tax features will not be accepted until mid- to late February. Those situations are:

1. Anyone who files a Schedule A
2. State and local sales tax deduction
3. Tuition and fees deduction for higher education
4. Educator expenses.

The IRS will announce specific dates later.

Estate tax law at last

The new estate tax top rate is 35% on anything above $5 million. Also, a person who dies and leaves everything to his or her spouse, and does not use up the $5M exemption, can also pass on the unused portion of the exemption to the spouse. Formerly this was done by setting up trusts, but the new law may make such trusts less necessary.

For executors and family of a person who died in 2010, the option exists to apply the new law as outlined above, or the law that existed during most of 2010, which was quite different. Under that law there was no estate tax, and the basis of inherited assets was treated differently.

Under the new law, the gift tax also has a $5M exclusion, as opposed to $1 million before.

Unfortunately the new estate tax law expires in 2013, unless Congress acts.

New law same as old

Many of the tax provisions that were scheduled to expire in 2010 or 2011 were revived by Congress in the recently passed tax bill. The specifics of the bill are still hard to come by. If you are viewing this from my web site, you can e-mail me with a question that applies to your tax situation.