Sunday, November 17, 2013

Tax "Mis-Information"

Have you received an email with a situation describing how the Federal or State government has passed a law to _____________ (fill in the blank)?  The story sounds quite possible and believable but after digging around and going to a true reference source it turns out to be an "urban legend".  As a tax advisor, I am often sorting out the truth from the fiction.  I think it's critical to ask questions of trusted advisors when you hear of some purported tax scheme, as there many tax court cases where the IRS wins due to erroneous understanding of tax laws, publications or even just frivolous arguments (for examples look for info on Wesley Snipes tax troubles). 

Some recent stories include the 3.8% sales tax on the sale of your home.  The origins of this revolve around the Affordable Care Act/Obamacare law that enacts an additional 3.8% tax on Net Investment Income. Since the sale of a home is generally a capital gain (investment income), the sale of a home MAY be subject to this tax. But there are a couple of hurdles that have to be overcome before this sale is subject to the 3.8% tax - 1) if this is your primary residence and has been owned and used as a primary residence for 2 years out of the last 5 years, the first $250,000 in gain ($500,000 for married taxpayers) is not taxable for income tax or the additional 3.8% tax, 2) the amount that exceeds item 1 then get transferred to Schedule D/Form 8949 and netted with any other gains or losses, if that is a negative then still not subject to the 3.8% tax, 3) the "last hurdle" is to see if investment income is over $200,000 single or $250,000 for married taxpayers and the amount that exceeds that threshold is subject to this additional tax.

As you can see this story started with a kernel of truth but then grew from there.  This also demonstrates that the US tax laws can be overly complicated and difficult to understand or to explain. Because of these reasons, I highly suggest discussing your situation with an advisor that can clearly explain the tax impact of choices before you make that choice because there may be a better way to structure a transaction but you can't make changes once it is done.

Is there a tax question you want to discuss? Send me a comment and I may be able to address that request.

Saturday, November 9, 2013

Defer income or pay tax now?

As an accountant, I generally like things to be "black and white" and have a high degree of certainty.  When dealing with taxes and planning through the year, that high degree of certainty is generally thrown out the window because no one can foretell the future.  Like investing, we can look back and analyze the past for probability of changes and which direction that change may lead, but there is still uncertainty involved in that process.

Most of the during the year planning our office does involves minimizing the taxes for the current year.  That historically is the easiest type of planning because the laws are in place for the current year.  We can plan steps to defer income or increase deductions to the current year.  That leads to a favorable short term outcome but considerations of beyond this year need to be considered so that this year'is actions are not detrimental in a future year.  I observed this several years ago when the large deduction was allowed for SUVs, the full allowed deduction would be taken in one year but the vehicle was financed and payments extended 4-5 years into the future with no major tax break after the first year.  Explaining and understanding these choices can be very beneficial for both the taxpayer and the advisor.

When asked if a deduction should be accelerated or income deferred, my answer is often "it depends". Some of the considerations include: 
- Am I near a change in marginal tax brackets?
- Do I expect income to be higher or lower in the future?
- Does my income exceed thresholds for tax credits?
- Will my income level impact available health insurance subsidies?
- Will I exceed allowable limits on earnings for early Social Security recipients?
- Is my income going to impact Medicare premiums?
- Does lowering my income affect my application for financial aid, sale of my business, line of credit with the bank, ability to refinance my house?
- Do I need the additional income now versus saving for retirement?

And there are other considerations that you may think of that I have not listed, some tax considerations and some not.  Everyone's situation is unique and as such needs attention as such.  I recommend that you review your financial situation more frequently than just at tax filing time.  We call current year planning appointments "mid-year" because it is still during the year and before the clock strikes midnight on 12/31 there is still time to take some action to impact your current year taxes.  

Strive to learn more about your particular situation and take steps to improve your situation.  If you need assistance, please seek the advice of a competent professional.