Guest Blogger: Examining the American Taxpayer Relief Act of 2012

Examining the American Taxpayer Relief Act of 2012

By Eric T. Johnson, J.D., LL.M.

The tax law has changed once again, but this time with greater permanency than the extensions the Congress cobbled together over the past six or seven years. Whatever the substantive merits or demerits of the legislation, the American Taxpayer Relief Act of 2012 has at least created an environment that is stable tax wise. Now to change the tax law the Congress would have to pass something affirmatively, and the financial services professionals have witnessed for themselves the difficulty that is in the current political climate.

So planning — at least planning without the hedges and contingencies or short-term horizon — is once again possible and there are a number of issues that must be considered on behalf of clients. For most taxpayers, the rules that sprung out of the tax laws passed at the beginning of the 21^st century have been made permanent. But for other taxpayers — loosely described as wealthy — there are changes, which they and their advisors must take into account.

While the tax rate structure familiar to accountants over the past ten years has been retained, new after a 12-year absence is a highest 39.6-percent tax rate applicable to wealthy taxpayers as so defined. Wealthy taxpayers are those with taxable income in excess of $400,000 for single taxpayers, $425,000 for heads of household, $450,000 for married taxpayers filing jointly, and $225,000 for married taxpayers filing separately. Such taxpayers also have a 20-percent maximum tax rate on long-term capital gains and qualifying dividends that would otherwise be taxed in the 39.6-percent bracket.  A marriage penalty arises because the place where this bracket begins for a married filing jointly is only 12.5 percent higher than where the bracket for an unmarried individual begins. That marriage penalty will also be felt in the case of personal exemptions and itemized deductions. The cutbacks in such items are back in force, but only apply to taxpayers whose AGI exceeds $250,000 ($275,000 for heads of household; $300,000 for married filing jointly; and $150,000 for married filing separately). 

Trusts and estates in many cases face higher taxes because their 39.6-percent rate begins at a considerably lower level of taxable income ($11,950 in 2013). Estates and trusts face a major hurdle: capital gains are ordinarily not included in distributable net income and therefore cannot be distributed out to the beneficiaries. Given the disparity as to where the NII tax kicks in for individuals (beneficiaries) and fiduciaries, the strategy of spreading investment income among multiple taxpayers — many or all of whom have a significant threshold — and away from the highly vulnerable estate or trust that has a low threshold, is thwarted in most cases. New trust instruments (and wills) must be written differently than in the past in order for the trust to avoid higher than necessary taxes on both its ordinary income and its capital gains. Planners must also inquire into various techniques that might enable a reformation of current trusts that will produce lower aggregate taxes of the entity and its beneficiaries.

In addition, and new for 2013, are two taxes, the first on excess earned income and the second on net investment income. Earned income is defined as excess if it exceeds $200,000 (unmarried taxpayer) or $250,000 for all other taxpayers ($125,000 filing separately). This tax does not depend on AGI or taxable income so the tactics taken to plan for it will differ from those of the income tax and the tax on net investment income. This latter tax imposes an additional tax on as much of the net investment income as does not exceed the taxpayer’s AGI: if taxpayer has $40,000 of net investment income but only $10,000 of excess AGI, the tax is imposed on $10,000, while if taxpayer has $30,000 of net investment income and $50,000 of excess AGI, the tax is imposed on $30,000. Planners will be focused on controlling a taxpayer’s AGI and the timing and character of income. The threshold AGI above which a taxpayer has excess AGI is the same as the limits of earned income discussed above. Because business owners are now likely to face increased capital gains tax and net investment income tax, qualified small business stock is making the C corporation more attractive and asset sales more attractive than entity sales, although there is some relief for sales of pass-through entities.

The estate and gift tax reforms enacted in 2010 nominally just for 2011 and 2012 were made permanent but at the cost of raising the highest transfer tax rate to 40 percent. The now permanent (and indexed) high exclusion amount (and applicable credit amount) has a significant impact on estate planning going forward. Planning for the use of the applicable credit amount has been at the heart of testamentary estate planning.  If a married couple does not take steps to utilize the first spouse’s applicable credit amount, it will be wasted.  As a result, estate planners would tend to advise all of their clients with estates in excess of $5,250,000 to plan to use the applicable credit amount.  However, this has become more complicated due to the permanence of portability election, which can double this basic exclusion amount. Far more important than perhaps the marital deduction is securing the basis step up at death. With many clients not likely to need to avoid the federal estate tax even with full inclusion, flexibility must be a design feature that will enable inclusion in the estate to further the income tax purpose for appreciated assets while retaining the ability to keep assets out of the estate should they depreciate in value. 

The above topics and many more are analyzed in detail in Surgent McCoy’s Best Income Tax, Estate Tax, and Financial Planning Ideas of 2013. 

Eric T. Johnson is a graduate of Princeton University (A.B.), Villanova Law School (J.D.), and New York University (L.L.M (Taxation)). He has practiced law in the tax and estate planning areas in Philadelphia and its suburbs. Eric has taught courses at Villanova School of Law Graduate Tax Program and for the Pennsylvania Bar Institute, and has been on the faculty of the American College in Bryn Mawr, Pennsylvania. He has developed over 80 courses at Surgent McCoy as its head writer.

The Global Internship: Midnight in Paris

Editor's note: This is the latest in a series of blog posts from VSCPA student member Shannon Case (below), a graduate student at Virginia Commonwealth University (VCU). Look for more posts in the coming weeks detailing Shannon's experience as an intern in KPMG's London office.

By Shannon Case
KPMG
 

As soon as we got out of work, we hopped on a train and headed to Paris for the weekend! As soon as our train got in around midnight, we headed straight to the Eiffel Tower (hence the title Midnight in Paris). A fellow global intern is doing a rotation in Paris, so we thought it would be a great idea to visit him and share his place for the weekend. He visited us the weekend before in London and we all had an amazing time sightseeing together and sharing stories from our first weeks as interns in different countries. We knew France would be celebrating Bastille Day, so we thought it would be a great time to head to Paris.

 
On Saturday we went to Versailles which was one of the most gorgeous places I have ever visited in my life. The palace itself was magnificent, but I also loved the many gardens that surrounded the palace. At first we were unsure whether or not we would have enough time to go to Versailles, but I am so glad that we decided to go there. I would highly recommend it to anyone going to France. The Hall of Mirrors was one of my favorite places in the palace. I also loved the garden outside the Grand Trianon which was filled with white lilies and gorgeous views of the palace canals. It was a great day!

On Sunday I spent the day exploring the city of Paris. I decided to go to the Louvre and Notre Dame, but I also managed to take a river tour on the Seine which was really nice.  Touring on the river provides an entirely different view and I managed to snap some great pictures. After a day of sightseeing, I headed down to the Eiffel Tower and saw some fireworks and enjoyed some great food for Bastille Day. Our trip to Paris was a great experience and I definitely crossed many items off of my bucket list!

Guest Blogger: IRS Guidance on Same-Sex Marriages

By Edward Zollars, CPA

The IRS issued its eagerly awaited guidance of how the Supreme Court’s Windsor decision would be applied overall in federal taxes in Revenue Ruling 2013-17 (http://www.irs.gov/pub/irs-drop/rr-13-17.pdf).

The ruling specifically looked to answer three questions that were not necessarily clear under the IRC following the Windsor decision:

• Would the IRS use, to borrow Justice Scalia’s terms from his dissent, the state of current domicile, state of celebration or state of domicile at the time the marriage is entered into to determine marital status for federal tax purposes?
• Would there be a difference in dealing with IRC provisions that refer specifically to “husband,” “wife,” or “husband and wife” as opposed to those that refer only to “spouse” or similar gender-neutral terms?
• Does the treatment as married extend to couples in relationships defined by state law that are not denominated as marriage (such as registered domestic partners or civil unions) but may grant rights “as if” the couple were married?

To answer the first question (which state’s laws control) the IRS turned initially to its analysis of common-law marriage issues found in Revenue Ruling 58-66.  Under that ruling if a couple established a common-law marriage in a jurisdiction that recognizes the same, a later relocation to a state that refuses to recognize a marriage unless the couple has a formal marriage ceremony does not change their status as married for federal tax purposes.

The IRS notes, first, that this “once married, always married even if the couple relocates” has been used successfully for common-law marriages for over 50 years.  The IRS also finds that a uniform rule gives a simpler tax administration than would be true under alternative treatments, including changes in “related party” status under various IRC provisions (for instance, IRC §318) for a couple merely by relocating to a state that did not recognize the marriage and complications for employers that operate in more than one state, greatly complicating administration of employee benefit plans.

Thus, the IRS has amplified Revenue Ruling 58-66 (the common-law marriage ruling) to cover same-sex marriages as well.  So long as the marriage is valid in the state in which it is entered into, it will be recognized for federal tax purposes.  A footnote to the ruling clarifies that the same rule would apply if the marriage were celebrated in a foreign jurisdiction that recognized the marriage.

The IRS also decided that it would not attempt to differentiate those provisions that contain a gender specific reference to parties in a marriage (that is “husband” and/or “wife”) and rather treat all such references in a gender neutral form.  Effectively this means that where such words are found, the adviser should simply read “spouse” or “spouses” instead of the gender specific wording.

Finally, the IRS also ruled that if a state establishes a status that is not deemed married under state law (such as a registered domestic partnership or a civil union) the parties will not be treated as married for federal tax purposes.  This holding is contrary to an information letter issued back in 2011 by the IRS regarding Illinois civil unions involving opposite sex couples issued to a national tax preparation firm.

Finally there arises the question about what do about returns already filed or 2012 returns on extension and either not yet filed, or filed after the issuance of the Windsor decision.  And, unfortunately, the ruling leaves some of these questions open.

The ruling clearly allows a taxpayer to rely on this ruling to file original returns, amended returns or claims for refund for any return for which the statute of limitations remains open.  The ruling notes that if a taxpayer does file such a claim for refund, the return must consistently treat the couple as married for all purposes—so the taxpayer cannot “cherry pick” to exclude the value of medical insurance paid for a same-sex spouse from income but ignore dealing with negative consequences that arise due to being required to use a rate schedule of either married filing joint or married filing separately.

The ruling does note that the ruling will be applied prospectively as of Sept. 16, 2013.  The IRS in its FAQ released along with the ruling holds that if a 2012 return is not actually filed by Sept. 16, 2013, the taxpayer must file using either married filing jointly or married filing separately.  However, a taxpayer who files before that date has the option of filing using either the married status or filling as if DOMA had not been overturned (that is, as not married).

Since a “marriage penalty” occurs in most (but not all) cases for income tax purposes, some taxpayers may now be facing a filing deadline one month earlier than they believed would apply.

Young Professionals Corner: Starting Off Strong

Editor's note: This is the latest in a series of guest posts from young VSCPA members dealing with topics of interest to young professionals. If you'd like to write or have a topic you'd like a future blogger to cover, please email VSCPA Academic & Career Development Coordinator Tracey Zink.

By Theresa Lee, CPA
AOL Inc.

After graduation and a well-earned vacation, it is the time of year when recent accounting graduates join the workforce and public accounting firms have classes of their newest associates starting.  Here are a few Dos and Don’ts to help you have a successful start to your career:  

Do: Ask questions. Learn from your peers, the staff who are one year above you, your seniors, managers and partners. Try to ask questions to the appropriate level and think through your questions before you ask them. You will learn a lot by thinking through how you would approach an issue and then having your supervisor explain how their resolution is different.  

Don’t: Complain. Every accounting role comes with long hours depending on the time of month or year. Keep a good attitude. Trust me, not one of your supervisors wants to be at work at 10pm. And absolutely no one wants to be at work at 10 p.m. with a team member who complains about working late. You are all in this together and keeping a good attitude keeps the team moving with less distraction.

Do: Select the correct method of communication to get your message and the tone across. Learn how your company uses in-person meetings, phone calls, e-mail, and IM for various purposes.  Also consider your audience when communicating.  

Don’t: Take offense when you receive review comments. You are new and have a lot to learn from on-the-job experience. The person who gave you those comments can do the work themselves much faster but choose to take the time to leave review comments, wait for you to clear the comments and bring up questions, and then check that the comments were cleared properly. Review comments are a teaching method. Should you really complain about your supervisor investing time and effort in your professional development?

Don’t: Be “that” guy or girl at the company happy hour. Participate in company and department events, especially charitable events and sports teams, but do not be the person who has one too many.  Try ordering a drink you don’t like so you can maintain the appearance of participating in happy hour while remaining in control.

Do: Admit when you make a mistake. Bring it to the attention of your supervisor immediately and in a professional manner. This means laying out the facts, the impact of the mistake, and proposing a plan to fix it. Everyone makes mistakes. Strong performers know how to communicate their mistakes and address them before they become problems.  

Don’t: Get overwhelmed with work, put your head down, and try to work through the night to finish your growing to-do list. Ask your supervisor or mentor for help prioritizing your work. If something takes you significantly longer than you think it should, you are probably spinning your wheels. Stop and ask for help.  

Do: Volunteer to help out, even if you have no idea how to do the work or it is a mundane task. This is a great way to learn something new and show your initiative. Mundane work has to get done and you will stand out for your good attitude and willingness to help the team. You might even get picked to work on the next exciting project. Hard work does pay off.

Theresa Lee, CPA, is a certified public accountant and a lead accountant in AOL’s Advertising Revenue department.  She has an master's in business administration in finance from The George Washington University and a bachelor's in business administration in Accounting from James Madison University. She has six years of experience in public accounting performing audits of technology, government contracting, and private equity clients and two years of experience in internal audit prior to joining AOL. She lives in Reston with her husband.