Congressional Actions in the Final Months of 2010

Year-end financial tax planning – which always involves some educated guesswork – is a bigger challenge this year than in past years. The recent elections have changed the Congressional landscape, with Republicans winning control of the House of Representatives and picking up seats in the Senate. There are a number of tax laws the lame duck congress will still have to deal with, and though it is too early to know exactly how changes in Congress will affect open tax issues for 2010 and 2011, we offers some suggestions for saving tax dollars.

When the “lame-duck” congress returns this month, it must decide whether or not to “patch” the alternative minimum tax (AMT) for 2010 (increase exemption amounts, and allow personal credits to offset the AMT) as it has done in past years. It also must decide whether or not to retroactively extend a number of tax provisions that expired at the end of 2009, including the election to take an itemized deduction for State and local general sales taxes in lieu of the itemized deduction permitted for State and local income taxes, and the additional standard deduction for real estate property taxes.

Congress must also decide whether or not to extend the Bush tax cuts, which will expire at the end of this year, for some or all taxpayers. Without Congressional action, individuals will face higher tax rates on their income, including capital gains. Also, unless Congress intervenes, the estate tax, which isn’t in effect this year, will return next year with a 55% top rate.

With all of this in mind, we have compiled a checklist of actions that can help you save tax dollars if you act before the year-end. Not all actions will apply in your particular situation. Please review the list and contact us with any questions regarding how these items will affect your specific tax situation.

Year End Moves for Individuals

• If you did not set aside enough this year in your employer’s health flexible spending account (FSA) consider increasing the amount for 2011. If you are eligible to contribute to a Health Savings Account (HSA) make your contributions before the end of the year. Remember that after 12/31/10 over the counter medications no longer qualify for payments from these accounts.
• Increase your withholding if you will be facing a penalty for underpayment of federal estimated tax.
• Make energy saving improvements to your main home, such as putting in extra insulation or installing energy saving windows or buying and installing an energy efficient furnace, and you may qualify for a 30% tax credit.
• Consider converting your traditional IRA into a Roth IRA, if doing so is expected to produce better long-term tax results for you and your beneficiaries. Please call our office if you would like us to assist you with this calculation.
• Take required minimum distributions (RMD) from your IRA or 401(k) plan if you have reached age 70 ½.
• Make annual gifts that are under $13,000 per individual to take advantage of the annual gift exclusion. The transfers also may save families’ income taxes where income-earning property is gifted to a family member in a lower tax bracket who is not subject to kiddie tax.
• Donate to your favorite qualified charitable organization.

Fred's Story - Asset Depreciation

“How can I owe $5,000 in taxes when I do not have any money in the bank?” asked Fred Lock from across the desk as we reviewed his tax return. Fred is owner of The Best Hoagie, a local sandwich shop.

“Fred your question is not an uncommon one,” I responded. “You believe that you pay taxes on your income, and you consider your money in the bank your income, correct?”

“Exactly” Fred exclaimed,” How can they charge me taxes on money I do not have?”
Fred listened as I began to explain: “Fred let’s start with your sales or revenue. Your sandwich shop collects cash at time of the sale. Correct?”

Fred confirmed, “Yes, the total cash I receive in the till equals my total sales.” We agreed that the income or revenue portion of his taxable income is straight forward. I continued the explanation by listing items that subtract from revenue, items otherwise known as expenses.
“You pay business expenses or cost of goods sold and operating expenses. In your case, the cost of items you sell such as meat, cheese, bread and other items are what we call your cost of goods sold. Your operating expenses are items such as rent and payroll. You pay cash to your suppliers and your employees weekly, and you pay rent monthly. This is all very familiar to you. “

The look on Fred’s face confirmed that the cash in for sales and the cash out for expenses are familiar concepts. He nods his head and I continued, “These items are only a portion of the taxable income story. The other items that affect your taxable income are not items you deal with as frequently. In order for me to calculate your taxable income the tax code requires that I consider items you have purchased that will be used in the business for over 12 months. These items must be capitalized. It is a common misconception that the cost of an item is what determines whether it needs to be capitalized, but in reality it is the ‘useful life’ not the cost. For example, a mixer that cost you $50 is capitalized because it will last longer than one year. An item that is capitalized is expensed or deducted according to depreciation rules set in the tax code.” Fred was nodding to confirm his understanding. “What is something you have purchased recently, that you will keep longer than one year?” I asked.

“I purchased a refrigerator case last week for $8,000, to hold the meat and cheese. The bank financed it for me for 10% interest with payments over 5 years,” said Fred.
I drew the following table on the whiteboard to explain how this purchase affects his taxable income and cash flow.

Cash Flow

	Year 1	Year 2	Year 3	Year 4	Year 5
Operating Income (Revenue-Expenses)	50,000	50,000	50,000	50,000	50,000
Loan Payments	(2,028)	(2,028)	(2,028)	(2,028)	(2,028)
Cash Flow	47,972	47,972	47,972	47,972	47,972<>

Taxable Income

	Year 1	Year 2	Year 3	Year 4	Year 5
Operating Income (Revenue-Expenses)	50,000	50,000	50,000	50,000	50,000
Deductible Interest Expense	(742)	(606)	(455)	(290)	(106)
Deductible Depreciation Expense	(8,000)	0	0	0	0
Taxable Income	41,258	49,394	49,545	49,545	49,894<>

*On September 27, 2010 the President signed into law the “Small Business Jobs Act of 2010”. This new law contains a wide-ranging assortment of tax breaks and incentives for businesses. Many of these tax breaks are what we tax professionals call accelerated depreciation deductions. The refrigerator case qualifies for Section 179 depreciation. That is why we have deducted the $8,000 in year one.

“Fred as you can see this one item creates a substantial difference between cash flow and taxable income,” I conclude. He smiled, beginning to understand the ramifications of the depreciation rules on HIS tax bill.

We hope this story helps you to understand how a purchase that is capitalized can affect your taxable income. Please email or call our office if you would like more information on this new tax bill and how it will affect your specific situation.

Are you having the correct amount withheld?

Information about withholding for you or your employee

We have all experienced the first day of a new job facing the form W-4, aka. the Employee’s Withholding Allowance Certificate. We read through the form's instructions or count the number of people in our family then fill in the number. What does it all mean?
The W-4 does its job of communicating to your employer how to calculate the amount of federal and state income tax to withhold from your paycheck, but it does not prevent you from experiencing a big surprise at tax time. The withholding tables are based on a simple calculation that annualizes your paycheck for that pay period and calculates the amount of withholding needed. Annualizing means it is assumed that your annual income will be the current paycheck multiplied by the number of pay periods during the year. The W-4 does not take into account any of your deductions, or income from other sources (such as a spouse’s wages).

It is possible to manage your withholding in order to have confidence that you will not receive a large refund or find yourself with an unexpected tax bill or penalty. Unfortunately, it is not usually as simple as counting yourself and your dependents and inserting the number.
If you would like us to assist you in doing a tax estimate for 2010 please call our office.
What are some of the new tax changes and how will they affect you?

There are many tax law changes for 2010 and 2011.
The legislature will continue to debate and enact legislation for this and future years. The discussion and speculation about what congress will do is conflicting and full of assumptions and hopes. The truth is that we do not know for sure what congress will do with regard to taxes or anything else for that matter.

Here are a few of the changes that may affect you.

Age increases for children covered by parent’s health insurance
Employer-paid health insurance premiums for children under age 27 are now tax-exempt to the employee. The child does not need to be a dependent. Previously deductions were only allowed for dependent children.

End of over-the-counter medication from medical savings accounts
Limit reimbursement of over-the-counter medication from HSAs, FSAs and MSAs. The new law excludes the cost of over-the-counter drugs not prescribed by a doctor from being reimbursed through a health reimbursement account (HRA) or health flexible savings accounts (FSAs) and from being reimbursed on a tax-free basis through a health savings account (HSA) or Archer Medical Savings Account (MSA), effective for distributions made after December 31, 2010. SO STOCK UP!!

Itemized Deductions will not be limited this year
In the past taxpayers with higher adjusted gross income lost a portion of the benefit from their itemized deductions. The limitation on personal exemptions and itemized deductions (a/k/a the “phaseout of the phaseout”) for taxpayers with higher AGIs is completely eliminated for 2010 only, unless new legislation is passed.

2010 Changes Opportunity to Convert Traditional to ROTH IRA
The limitation on converting traditional IRA to ROTH IRAs is no longer limited to taxpayers with modified adjusted gross income under $100,000. In 2010 only, if you convert a traditional IRA to a ROTH IRA you can elect to have the additional taxable income spread over a two-year period (2011-2012) If this is something you are considering please let us know and we will help you calculate the tax implications

Business Updates August 2010

A few Tax Changes that may affect your businesses

The economic climate has been slow in recent years. This year has presented many challenges for most businesses including lower sales, less available funding and increased regulatory burden. The government has passed a bill intended to encourage businesses to hire new employees. If you are considering hiring a new employee, or have recently, these incentives may help you.

The President signed into law the “Hiring Incentives to Restore Employment Act of 2010”. The centerpiece of this Act is a payroll tax holiday and the up-to-$1,000 tax credit for businesses that hire unemployed workers.

The Payroll Tax Holiday

The payroll tax holiday is an exemption for the employer share of social security taxes on wages paid to qualified newly hired employees after 02/03/10 and before 01/01/11. The employees must certify that they were not employed more than 40 hours during the 60 day period immediately preceding employment with you.

The HIRE credit

The HIRE credit is a general business credit of up to $1,000 for each qualified retained worker. This credit will be made available to those that qualify for the 2011 tax year.

Small business Health Insurance Credit

Small businesses that pay employees health insurance may qualify for a credit of up to 35% of employer-paid premiums paid by qualified employers. Qualified employers have: 25 or fewer full-time equivalent employees, average annual wages of no more than $50,000, and at least 50% of self-only level premium paid for covered employees. (Cafeteria plans do not qualify)

Section 179

The Hire Recovery Act keeps the Sections 179 depreciation deduction up at $250,000 for 2010 which are the same limits that were in effect for 2008 and 2009. If the law had not been passed, these dollar limits would have dropped this year to $134,000.

Wages for S Corporation Shareholders

The IRS continues its case against using S Corporations as a way to minimize Medicare and Social Security taxes. In a recent district court case the IRS claims that a portion of the dividend distributions by S Corporations should be recharacterized as wages subject to employment taxes.

This is a hot subject. The recent bill American Jobs, Closing Tax Loopholes and Preventing Outsourcing Act of 2010 that passed the House on May 28, 2010, contained a provision that would clamp down on certain service professionals who try to minimize Medicare and Social Security taxes by routing their self-employment income through an S Corporation and then pay themselves a nominal salary.

As you can see wages that are paid to shareholders out of an S Corporation are under scrutiny. We encourage you to review the wages you as an owner are paying out of your S Corporation to be sure it is reasonable. We are happy to assist you in evaluating the shareholders salary in your S Corporation. Please call or email today.