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Monica Rebella, CPA/IAR - President

Rebella Accountancy

 

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Feature Articles

 

- White House, Congress seek to avert Fiscal Cliff


- Additional 0.9 percent Medicare tax on wages starts January 1st
 

- Bonuses and year-end tax planning
 

- FAQ: Should I convert to a Roth IRA before 2012 ends?
 

- How do I use low interest rates to my tax advantage?
 

- December 2012 tax compliance calendar

 

 

 

Additional 0.9% Medicare Tax - Bonuses & Year End Tax Planning - Should You Convert to a Roth Before 12/31/12? - Jumping Off The Fiscal Cliff



President Obama’s health care package enacted two new taxes that take effect January 1, 2013.

One of these taxes is the additional 0.9 percent Medicare tax on earned income; the other is the 3.8 percent tax on net investment income.

The 0.9 percent tax applies to individuals; it does not apply to corporations, trusts or estates.

 

The 0.9 percent tax applies to wages, other compensation, and self-employment income that exceed specified thresholds.

 

Additional tax on higher-income earners

 

There is no cap on the application of the 0.9 percent tax. Thus, all earned income that exceeds the applicable thresholds is subject to the tax. The thresholds are $200,000 for a single individual; $250,000 for married couples filing a joint return; and $125,000 for married filing separately. The 0.9 percent tax applies to the combined earned income of a married couple. Thus, if the wife earns $220,000 and the husband earns $80,000, the tax applies to $50,000, the amount by which the combined income exceeds the $250,000 threshold for married couples.

 

The 0.9 percent tax applies on top of the existing 1.45 percent Hospital Insurance (HI) tax on earned income. Thus, for income above the applicable thresholds, a combined tax of 2.35 percent applies to the employee’s earned income. Because the employer also pays a 1.45 percent tax on earned income, the overall combined rate of Medicare taxes on earned income is 3.8 percent (thus coincidentally matching the new 3.8 percent tax on net investment income).

 

Passthrough treatment

 

For partners in a general partnership and shareholders in an S corporation, the tax applies to earned income that is paid as compensation to individuals holding an interest in the entity. Partnership income that passes through to a general partner is treated as self-employment income and is also subject to the tax, assuming the income exceeds the applicable thresholds. However, partnership income allocated to a limited partner is not treated as self-employment and would not be subject to the 0.9 percent tax. Furthermore, under current law, income that passes through to S corporation shareholders is not treated as earned income and would not be subject to the tax.

 

Withholding rules

 

Withholding of the additional 0.9 percent Medicare tax is imposed on an employer if an employee receives wages that exceed $200,000 for the year, whether or not the employee is married. The employer is not responsible for determining the employee’s marital status. The penalty for underpayment of estimated tax applies to the 0.9 percent tax. Thus, employees should realize that the employee may be responsible for estimated tax, even though the employer does not have to withhold.

 

Planning techniques

 

One planning device to minimize the tax  would be to accelerate earned income, such as a bonus, into 2012. Doing this would also avoid any increase in the income tax rates in 2013 from the sunsetting of the Bush tax rates. Holders of stock-based compensation may want to trigger recognition of the income in 2012, by exercising stock options or by making an election to recognize income on restricted stock.

 

Another planning device would be to set up an S corp, rather than a partnership, for operating a business, so that the income allocable to owners is not treated as earned income. An entity operating as a partnership could be converted to an S corp

 

If you have any questions surrounding how the new 0.9 percent Medicare tax will affect the take home pay of you or your spouse, or how to handle withholding if you are a business owner, please contact me at the office.


 


Bonuses and Year End 2012 Tax Planning

 

As the end of the calendar year approaches, taxpayers ordinarily prefer to minimize current-year income by deferring the inclusion of taxable income to the following year, while accelerating deductions to the current year.

 

However, as many taxpayers are aware, individual income tax rates may increase in 2013, with the potential for dramatic increases for higher-income individuals (if not all individuals).

 

While it is unclear how many taxpayers will see tax increases in 2013, it is certain that rates will not be any lower than they are in 2012. Thus, some, if not all, individuals will have an incentive to accelerate income into 2012.

 

Annual bonuses for 2012

 

Employees earning annual bonuses for services performed in 2012 ordinarily would receive the bonus in 2013. And generally the employer would take the deduction in 2013. However, some employees may prefer to receive the bonus in 2012, to take advantage of the lower current tax rates. An employer may want to deduct the bonus in the earlier year, to reduce taxable income. The IRS recently issued Chief Counsel Advice (CCA 201246029) on the treatment of a bonus that illustrates some of the practical obstacles to accelerating bonus income.

 

A lesson learned

 

In the CCA, the employer awarded bonuses for the calendar year (the year of service) based on company performance. The total bonus amount accrued for financial accounting purposes at the end of the year. The bonuses were paid early in the following year, after the employer finalized the amounts, provided that the employee still worked for the company.

 

In Rev. Rul. 2011-29, the IRS determined that the employer can accrue liability, and take a deduction, for bonuses in the earlier year, where the employer can establish the fact of the liability for bonuses paid to a group of employees, even though the recipients’ identities and amounts payable were determined in the following year. In contrast, in the CCA, the IRS concluded that the taxpayer’s liability to pay bonuses was not fixed until the contingency was satisfied – the employee had to be still employed on the date of payment. Therefore, the bonuses were not deductible until the following year, when they were paid.

 

While the CCA does not discuss it, presumably if the employer paid the bonuses in the year of service (2012), they would be deductible in that same year. The employees would take the bonuses into income in 2012, when tax rates were lower. Furthermore, the income would avoid the new 0.9 percent additional Medicare tax on earned income, which takes effect in 2013.

 

Important timing exception

 

In the CCA, the timing was identical for the employer and the employee. Under Code Sec. 404, concerning deferred compensation, the employer may not deduct the bonus until the same time that the employee takes it into income. Under an exception, however,  if the employer pays the bonus in 2013 but within 2 ½ months after the end of 2012, an accrual basis taxpayer can deduct the payment in the current year, even though the employee would not include it in income until it is paid in 2013. This presumes that the bonuses are fixed at the end of 2012 and that the employer does not use a plan like the one described in the CCA.

 


 

Should I Convert to a Roth IRA Before 2012 Ends?

 

With 2013 bearing down on us, we hope you have a moment to spare from holiday preparation for some good old-fashioned year-end tax planning. By now you must be familiar with the term “fiscal cliff” and how the expiring provisions, tax rates, and budget appropriations may affect small business, big business, and politics in Washington, DC.

 

However, the looming expiration dates for the Bush-era tax cuts and other tax provisions set to become effective in 2013 may also have consequences for how you save for retirement. This year we have advice for IRA account holders in particular:

 

Avoiding increased tax. If you have a traditional individual retirement account (IRA) and you are thinking about converting to a Roth so you can accumulate tax-free earnings, you might want to do it before the year ends. First, if you are in a high-income tax bracket, your taxes are likely to increase if the Bush-tax cuts expire. Converting from a traditional IRA to a Roth IRA creates a taxable event, and you may lose more money to the government by converting in 2013 than you would if you convert before 2012 ends.

 

Secondly, taxpayers whose projected 2013 adjusted gross income (AGI) will approach $250,000 (or $200,000 for single filers) may want to avoid converting their traditional IRA in 2013. The addition of their IRA assets to their AGI may push them within the income range limits for taxpayers subject to the 3.8 percent tax on net investment income that goes into effect in 2013.

 

Please note that the converted IRA assets would not themselves be subject to the 3.8 percent surtax. However the surtax would apply to any investment income the taxpayer has. Such investment income would include items such as (but not limited to) dividends, rents, royalties, interest, except municipal-bond interest, capital gains, and income from the sale of a principal residence worth more than the $250,000/$500,000 exclusions.

 

Undoing a conversion. You might be asking what would happen if you convert to a Roth IRA in 2012 and then Congress extends the current tax rates. In such cases, you would have until October 15, 2013 to undo the transaction. You could put the money back into your traditional IRA as if you had never converted in the first place. In other words, there would be no taxable event.

 

2010 conversion and deferral. Taxpayers who already converted their traditional IRA to a Roth IRA in 2010 were given a one-time privilege of deferring half of the income from the conversion to 2011 and the other half until 2012. If taxpayers elected to defer their IRA conversion income in this way, the 2012 tax year has arrived. They must report that second half of their conversion income on their 2012 tax returns. If you are a taxpayer who must report income from a previous Roth IRA conversion in 2012, it might not be in your best interest to generate additional income by converting yet another IRA before the year ends.

 

Contributions. The 2012 year-end will also bring several changes to the rules on IRA contributions, which may affect your planning. In 2013, the limits on maximum annual contributions to an IRA will go up from $5,000 to $5,500 ($6,500 for contributors age of 50 and over, up from $6,000 in 2012). This increase in contribution limits is the first time the IRS has adjusted the limit since 2008.

 

The adjusted gross income level at which taxpayers must begin to phase-out their contributions will also go up in 2013.

 

Income levels for a traditional IRA contribution

2013

2012

Singles

$59,000 to $69,000

$58,000 to $68,000

Married (filing jointly)*

$95,000 to $115,000

$92,000 to $112,000

Married (filing jointly)**

$178,000 to $188,000

$173,000 to $183,000

*If the spouse who makes the IRA contribution is covered by a workplace retirement plan.
**If the contributing spouse is not covered by a workplace retirement plan, but is married to a spouse who is covered.

 

Income levels for a ROTH IRA contribution

2013

2012

Singles

$112,000 to $127,000

$110,000 to $125,000

Married (filing jointly)

$178,000 to $188,000

$173,000 to $183,000

 

However, tax planners should note that the deadline for making IRA contributions for the 2012 tax year remains unchanged. You still have until your filing date, which is April 15, 2013, to make contributions for 2012.

 


 

Jumping Off The Fiscal Cliff, Are There Rocks Down There?

Have you ever watched those people dive off cliffs?  Wow, they look graceful.  I always thought it looked really scary.  Heck, I'm not so sure I would go feet first.  On the way down it looks like you would scrape the side of the cliff.  However they do it, it looks great.  

 

By any account, in Washington, neither party Democrats or Republicans look very graceful as they are getting ready to jump off the cliff.

 

I don't believe it is the jump that worries me, it is how far down in the water we go.  Will we be able to catch our breath and swim to the top?  What kind of rocks are down there?  Are there sharks in the water?  If we are talking about Washington, there are sharks, piranha, whales, and mermaids, unicorns, ok, off topic....  Washington is filled with obstacles.  This is why I am unconvinced the right thing will happen.

 

Let's wind our clocks back to 2011 and look at the debt-ceiling battle.  I know many think the markets will sprint forward when they get the cliff resolved.  In 2011 stocks traded sideways and jumped around a bit much like today as the debt-ceiling debate got under way.  The sharpest drop came though once the debt-ceiling bill cleared on August 2, 2011.  In fact it dropped 10.6%, just seven days later.

 

I think the same thing will happen when the fiscal cliff gets "resolved."  If the sausage is made favorably and there are REAL cuts in budgets and similar tax increases, then stocks could soar.  On the other hand, if their is just tax increases and few cuts or cuts coming later (which will never happen) then the markets will get negative as they look out to Q2 in 2013 with a likely recession.  

 

The truth is, I don't know which will prevail.  You have to invest thinking both scenarios are possible.  This is why a balanced approach to investing always makes sense.  There are always some bargains out there.  I will keep in touch when news hits (likely before the 17th when Obama is going to Hawaii for an extended vacation).

 
 


 

   

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As always you can call me at 714-619-0667 if you have any questions about investing, retirement or any other tax & accounting related issues. 

 

Regards, Monica Rebella, CPA/IAR

President, Rebella Accountancy

 
Disclaimer:  The opinions contained herein are not intended to be investment advice or a solicitation to buy or sell any securities. With any investment you should carefully consider the investment objectives, potential risks, management fees, and charges and expenses before investing.  Past performance is not a guarantee of future results. The investment return and principle value of any investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost.

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Monica Rebella, CPA/IAR | President - Rebella Accountancy | Certified Public Accountants
507 E. First Street, Suite A | Tustin, CA 92780 | Phone: 714-619-0667 | Fax: 714-544-0236
Email: mrebella@rebellacpa.com | www.RebellaCPA.com | www.MyDentalCPA.com