“Gang of Six” plan to avoid default would include ambitious tax reform package.

In the afternoon of July 19, the “Gang of Six” deficit reduction plan aimed at avoiding a looming debt default appeared to be gaining traction in Washington. The plan includes substantial tax changes.

The President publicly endorsed the “Gang of Six” plan's overall approach, Senate Majority Leader Harry Reid (D-NV) offered it a qualified nod, Senator Roger Wicker (R-MS) is reported to have said the package could clear the Senate, and Senate Budget Committee Chairman Kent Conrad (D-ND), one of the bipartisan “Gang of Six” Senators, said the response he received from a number of his colleagues was very favorable.

Broad tax changes contemplated. The latest word about the plan is that it will shave $3.75 trillion off the deficit over ten years and will contain about $1.2 trillion in new revenues.

An unofficial summary of the bipartisan plan calls for the Senate Finance Committee within six months to report a comprehensive tax reform package that delivers “real deficit savings by broadening the tax base, lowering tax rates, and generating economic growth.” Specifics of the tax changes covered in the unofficial summary include:

• A single corporate tax rate between 23% and 29% and shift to a competitive territorial tax system.
• Tax simplification that involves reducing the number of tax expenditures (i.e., tax breaks) and reducing individual tax rates. There would be three tax brackets with rates in the range of 8%–12%, 14–22%, and 23%–29%. To the extent future Congresses find that the dynamic effects of tax reform result in additional revenue beyond initial targets, this revenue would go to additional rate reductions and deficit reduction, not to new spending.
• Permanent repeal of the alternative minimum tax (AMT).
• Reform, rather than elimination, of tax breaks for health, charitable giving, homeownership, and retirement.
• Retention of the earned income tax credit and child tax credit, or creation of an alternative that would provide at least the same level of support for qualified beneficiaries.

IRS Withholding Calculator

If you have too little federal tax withheld from your pay, you could end up owing a lot of money when you file your taxes. If you withhold too much, you will get a large refund next year, but that means you gave up the use of your money for several months during the year.

You may want to adjust your federal tax withholding with your employer. You should also evaluate your withholding if you have recently married or divorced, added a dependent, purchased a home, changed jobs or retired.

The withholding calculator at IRS.gov can help you figure the correct amount of federal withholding and provide information you can use to complete a new Form W-4, Employee’s Withholding Allowance Certificate.

Before you begin, have these items:

• Your most recent pay stubs.
• Your most recent federal income tax return.
• Here are some tips for using the withholding calculator:
• Fill in all information that applies to your situation.
• Estimate when necessary. But remember, the results are only as accurate as the information you provide.
• Check the information links embedded in the program whenever you have a question.
• Print out the final screen that summarizes your entries and the results. Use it to complete a new Form W-4 (if necessary) and give the completed W-4 to your employer. Keep the print of the final screen and a copy of your new W-4 with your tax records.

For many people, the withholding calculator is a great tool that can simplify the process of determining your withholding. (download via link below)

http://www.irs.gov/individuals/article/0,,id=96196,00.html

However, if you are subject to the alternative minimum tax or self-employment tax or if your current job will end before the end of the year, you will probably achieve more accurate withholding by following the instructions in Publication 919, How Do I Adjust My Tax Withholding, which is available at www.irs.gov

Call us at 979.846.4667 if you need a more detailed tax projection for 2011 or to discuss tax savings strategies.

IRS Urges Taxpayers to Avoid Becoming Victims of Tax Scams

The Internal Revenue Service today encouraged taxpayers to guard against being misled by unscrupulous individuals trying to persuade them to file false claims for tax credits or rebates.

The IRS has noted an increase in tax-return-related scams, frequently involving unsuspecting taxpayers who normally do not have a filing requirement in the first place. These taxpayers are led to believe they should file a return with the IRS for tax credits, refunds or rebates for which they are not really entitled. Many of these recent scams have been targeted in the South and Midwest.

Unscrupulous promoters deceive people into paying for advice on how to file false claims. Some promoters may charge unreasonable amounts for preparing legitimate returns that could have been prepared for free by the IRS or IRS sponsored Volunteer Income Tax Assistance partners. In other situations, identity theft is involved.

Taxpayers should be wary of any of the following:

• Fictitious claims for refunds or rebates based on excess or withheld Social Security benefits.
• Claims that Treasury Form 1080 can be used to transfer funds from the Social Security Administration to the IRS enabling a payout from the IRS.
• Unfamiliar for-profit tax services teaming up with local churches.
• Home-made flyers and brochures implying credits or refunds are available without proof of eligibility.
• Offers of free money with no documentation required.
• Promises of refunds for “Low Income – No Documents Tax Returns.”
• Claims for the expired Economic Recovery Credit Program or Recovery Rebate Credit.
• Advice on claiming the Earned Income Tax Credit based on exaggerated reports of self-employment income.

In some cases non-existent Social Security refunds or rebates have been the bait used by the con artists. In other situations, taxpayers deserve the tax credits they are promised but the preparer uses fictitious or inflated information on the return which results in a fraudulent return.

Flyers and advertisements for free money from the IRS, suggesting that the taxpayer can file with little or no documentation, have been appearing in community churches around the country. Promoters are targeting church congregations, exploiting their good intentions and credibility. These schemes also often spread by word of mouth among unsuspecting and well-intentioned people telling their friends and relatives.

Promoters of these scams often prey upon low income individuals and the elderly.

They build false hopes and charge people good money for bad advice. In the end, the victims discover their claims are rejected or the refund barely exceeds what they paid the promoter. Meanwhile, their money and the promoters are long gone.

Unsuspecting individuals are most likely to get caught up in scams and the IRS is warning all taxpayers, and those that help others prepare returns, to remain vigilant. If it sounds too good to be true, it probably is.

Anyone with questions about a tax credit or program should visit www.IRS.gov, call the IRS toll-free number at 800-829-1040 or visit a local IRS Taxpayer Assistance Center.

For questions about rebates, credit and benefits from other federal agencies contact the relevant agency directly for accurate information.

IRS Suspends Gift Tax Examinations of (Republican) Political Donors

WASHINGTON, D.C. (JULY 7, 2011)

BY MICHAEL COHN, ACCOUNTING TODAY

The Internal Revenue Service said Thursday it would stop its examinations of donors to tax-exempt 501(c)(4) political organizations asking whether they had paid gift taxes, after the agency came under pressure from Republican lawmakers.

The IRS sent letters earlier this year to at least five political donors questioning their donations to tax-exempt 501(c)(4) organizations, which are named after a section of the Tax Code (see IRS May Tax Political Donations as Gifts). In the letters, the IRS wrote, “Donations to 501(c)(4) organizations are taxable gifts, and your contribution in 2008 should have been reported on your 2008 Federal Gift Tax Return (Form 709).”

The 501(c)(4) organizations have become an increasingly popular vehicle for soliciting political donations as the donors do not have to be named by the groups. Republican-leaning groups like Crossroads GPS and Americans for Prosperity played a particularly large role in the 2010 elections, and Democrats have also begun organizing their own 501(c)(4) organizations.

In response to reports about the IRS probe, Republican lawmakers began asking the IRS for information about the inquiry (see Senators Question IRS on Gift Tax Enforcement and Political Influence and Congress Demands Answers from IRS on Gift Tax Probe). In response, the IRS said Wednesday it would stop pursuing the examinations.

“Recently, questions have arisen regarding the applicability of the gift tax to contributions to 501(c)(4) organizations,” said the IRS on its Web site. “The Internal Revenue Service has little history to draw from in this area and the limited guidance we previously issued on this matter is almost thirty years old. While we review the need for additional guidance or legislation, we will not use resources to pursue examinations on this issue. Any future action we take will be prospective and after notice to the public. As we consider this issue, it is possible that Congress may choose to clearly articulate through legislation the applicability of the gift tax to contributions to 501(c)(4) organizations.”

House Ways and Means Committee Chairman Dave Camp, R-Mich., who was the lawmakers questioning the IRS probe, welcomed the IRS announcement, but said he still wanted to know why the IRS had begun the examinations.

“I am pleased that following my and other inquiries questioning the motives behind these investigations, the IRS has decided to immediately suspend all current gift tax examinations in this area and will not begin any new investigations before issuing public guidance,” he said in a statement. “However, I remain troubled that the IRS has failed to explain what prompted these audits in the first place. It has yet to adequately address why taxpayers were given no warning prior to the launching of these investigations. Furthermore, the IRS has failed to clarify that the gift tax will not apply to future political donations. Especially troubling is that the directive explicitly leaves open the possibility of future audits. Given the lack of transparency, I will continue my investigation until the complete story behind the actions of the IRS has been told.”

Sen. Orrin Hatch, R-Utah, who had also written to IRS Commissioner Doug Shulman asking why the agency was conducting the examinations, said he too wanted to know more about the origins of the probe.

“This decision today ensures that the IRS remains free from even the hint of undue political influence,” said Hatch. “It cannot be turned into an arm of political retribution or payback. It must remain independent. While I commend Commissioner Shulman for making this decision, there are many unanswered questions that still need to be answered. Namely, why did the IRS choose to enforce this in the first place? And did politics play a role in that decision?”

Ofer Lion, a tax lawyer with Mitchell Silberberg & Knupp in Los Angeles who brought the IRS enforcement initiative to light, was pleased with the IRS’s decision. “I think it’s the appropriate response,” he said in an interview. “Instead of sending out letters to just five different donors, they should have taken up some public discussion and debate and issued some public guidance. That’s what should have happened, and that’s what they say will be their path going forward.”

He thinks the IRS won't conduct any further examinations until after the 2012 elections.

Planning for new 3.8% Medicare tax on unearned income

Effective in 2013, the Health Care and Education Reconciliation Act of 20101 will subject some individuals to a 3.8% Medicare contribution tax on unearned income. This new tax will apply to single taxpayers with a modified adjusted gross income (MAGI) in excess of $200,000 and married taxpayers with a MAGI in excess of $250,000 if filing a joint return, or $125,000 if filing a separate return. The provision is contained in new Sec. 1411, Unearned Income Medicare Contribution. Congress added the provision as a means of raising revenue to pay for health care reform. It targets wealthier taxpayers, as can be seen by the thresholds at which the tax applies.For most individuals, MAGI will be their adjusted gross income. The tax is equal to 3.8% of the lesser of net investment income or the amount by which MAGI exceeds the threshold.

Net investment income includes interest, dividends, annuities, royalties, and rents, other than such income that is derived in the ordinary course of a trade or business, less allocable deductions. It also includes income from a passive activity. It does not include distributions from qualified plans included in Secs. 401(a), 403(a), 403(b), 408, 408A, or 457(b). These sections refer to qualified pension, profit-sharing, and stock bonus plans; qualified annuity plans; annuities purchased by Sec. 501(c)(3) organizations or public schools; individual retirement accounts; Roth individual retirement accounts; and eligible deferred compensation plans, respectively. Net investment income also does not include tax-exempt interest.

Net gain attributable to the disposition of property other than property held in an active trade or business is subject to this tax. The taxable gain on the sale of a personal residence in excess of the Sec. 121 exclusion would be included.

Estates and trusts are subject to this tax .

Although Medicare tax assessed on self-employment income is deductible, the Medicare tax on net investment income is not deductible and is subject to the individual estimated tax provisions.

Planning and Analysis

Wealthy taxpayers have approximately a year and a half to develop methods and strategies for avoiding or reducing the impact of this new tax on investments. A good portion of the implementation of plans to limit this tax may take place in the last quarter of the tax year ending on December 31, 2012. This would be a good time for taxpayers to analyze their investment portfolios and harvest any year-end gains, thereby limiting the 3.8% tax on top of the income or capital gain tax assessed on the gains. Given that the wash sale rules do not apply to gains, selling a security at year end and repurchasing it may make sense if the investment is still a good portfolio choice.

Investors and financial planners have had an increased interest in dividend-paying securities since the implementation of the qualified dividend tax rate that came into effect under the Jobs and Growth Tax Relief Reconciliation Act of 2003. Investors may want to pass on capturing dividends and look to investments providing long-term capital gain. Of course, this is a deferral tactic, but potentially an investor may be close to retirement or a career change, at which time there may be a decrease in income. This deferral could end up as a permanent tax savings if the taxpayer’s MAGI falls below the taxable threshold.

Taxpayers will have more reason to look at tax-exempt bonds. The analysis of these investments in comparison to taxable interest investments would have to factor in the new Medicare rate. Typically, a taxpayer could gross up the interest rate on a tax-exempt bond with the inverse of their tax rate. So a 4% tax-exempt bond grossed up at the inverse of a 35% tax rate would provide for a taxable rate of interest of 6.15% (4% ÷ 65%). The gross-up number of 65% would need to be reduced by 3.8% in factoring the total rate of tax, including income tax and the Medicare tax. Therefore, the grossed-up taxable rate to use in comparing a 4% tax-exempt rate to a taxable rate would be 6.53% (4% ÷ 61.2%).

Income from nonqualified annuities will be subject to this new investment tax. The opportunity to convert the annuity or its income into an investment that would be excluded from the tax is limited. A long-term investor looking for tax deferral may want to consider post-tax IRA investments versus annuities on a go-forward basis because income from an IRA is not subject to this tax. Maximizing investments into any qualified plan as an alternative to other investments will provide for future savings since the income withdrawn from a qualified plan will not be subject to the Medicare tax.

Investors may look to other insurance products to avoid the new tax. The inside buildup of life insurance cash surrender value is not subject to the new Medicare tax, nor are life insurance proceeds that are excluded from income tax.

Rents are subject to the Medicare tax unless the rent is derived in the ordinary course of a trade or business. Investors in real estate would have more reason to look at the active real estate investors’ rules to determine if they could avoid this tax via the active classification. Active real estate investors need to spend more than one-half of their time specifically in the real property trades or businesses (out of their total trades or businesses). In addition, the materially participating taxpayer needs to perform more than 750 hours of services during the tax year in real property trades or businesses. Real estate investors need to consider the possibility of making an election to treat all interests in rental real estate as one activity, thereby aggregating all real property interests into one trade or business.

In the case of a trade or business, the tax applies if the trade or business is a passive activity. Active business ownership within a sole proprietorship, limited liability company (LLC), partnership, or S corporation would not lend itself to this tax. A passive investor in a trade or business housed within one of these flowthrough entities is not subject to self-employment tax under Sec. 1401 because the investor is not active in the business. Therefore, if a passive investor attempts to construct an argument that she is not passive to avoid the Medicare tax, she will end up being subject to self-employment tax. This is the case for an investment housed within an LLC or a partnership. Under present rules, investors in a trade or business housed within an S corporation can avoid the investor’s Medicare tax on their flowthrough income if they can argue that they were actually active and not passive investors and still not be subject to self-employment tax. Even so, there are the implications of no compensation or unreasonably low compensation while claiming to be an active participant for S corporation employee-owners. Sec. 1411 includes a special rule whereby it excludes from the definition of net investment income any item taken into account in determining self-employment income under Sec. 1401. Thus, a taxpayer should never pay both self-employment tax and the new Medicare tax on the same stream of income.

An owner of a passthrough active trade or business may find that a portion of the flowthrough income is actually subject to the Medicare tax. Any income, gain, or loss attributable to an investment of working capital will be treated as not derived in the ordinary course of a trade or business. Interest, dividend, and royalty income earned in the normal course of a trade or business would not be subject to this tax, but idle cash-producing investment income would.

Upon the disposition of an interest in a partnership or an S corporation, only the gain attributable to the disposition of nonactive assets would be subject to the Medicare tax. An owner of an interest in a business may find that it has both an active trade or business and a passive activity housed within the operating entity. The determination of the portion of the gain subject to this tax would be based on an allocation of the fair market values of all the assets (active and passive) immediately before the disposition of the interest.

A working interest in an oil and gas property that a taxpayer holds through an entity that does not limit the taxpayer’s liability, or one held directly, is not considered a passive activity. Therefore, arguably royalties from this type of investment would not be subject to the tax. This may be an area where the IRS needs to provide clarification. Oil and gas production payments, royalties, or other income arrangements would be subject to the Medicare tax if the investment was not a working interest.

For the most part, a wealthy taxpayer with investments that produce income is going to be subject to this tax. The new law does not take effect until tax years beginning after December 31, 2012. This provides a somewhat lengthy window of opportunity for a taxpayer to plan potential minimization strategies.