Monthly Archives: December 2013

House will not consider tax extender legislation in 2013

by Michael W. Blitstein, CPA 

Legislation to extend the group of expiring provisions commonly known as “tax extenders” will not be considered by Congress in 2013.  House lawmakers will begin their winter district work period on December 13th, but tax extender legislation is not on the legislative floor schedule and no markup is planned in the Ways and Means Committee.

The House is likely to consider legislation dealing with Medicare payment rates for physicians, a fiscal year 2014 budget conference agreement and, possibly, a conference report on the farm bill.

Rather than following its typical pattern of passing a one or two-year extension of tax incentives in late December, Congress could approve an extenders bill in 2014 that applies retroactively, possibly as part of larger comprehensive tax reform legislation.

CJBS, LLC is a Chicago based firm that assists its clients with a wide range of accounting and financial issues, protecting and expanding the value of mid-size companies. E-mail me at michael@cjbs.com if you have any questions about this posting or if I may be of assistance in any way.

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Divorce and I.R.S. Trouble for the Innocent Spouse

by Larry Goldsmith, CPA, J.D., M.A.F.F.

As a Financial Forensic CPA traveling down the road of hidden assets and hidden income, I often observe bad behavior meant to intentionally punish a former spouse.  More than once, I have seen fear in the eyes of an innocent spouse who simply signed her name to a joint tax return and is now being relentlessly pursued by the Internal Revenue Service collection division.

We all know how this happens; in preparation for a separation or divorce, some spouses seeking a better settlement will decrease their business profits by diverting income or by claiming improper business expenses. The trouble for the innocent spouse who has agreed to file a joint income tax return before or during the separation is that when the Internal Revenue Service or the State of Illinois discovers the unreported income, the taxing agencies will hold both the innocent and guilty spouse ‘jointly and severably’ liable for the under reported income taxes, tax penalties, and accrued interest. ‘Joint and severably’ liable simply means that the Internal Revenue Service will take the money from either spouse, without concern as to fairness.

Unfortunately, it is often the case that the guilty party who is hiding assets will allow the innocent spouse to be burdened by paying 100% of the tax debt. Last year a woman was referred to me. Her husband of three years was cheating on his income taxes and his business was audited by the IRS. The young woman was told by an IRS collections officer that since she filed a joint tax return she owed $220,000. The IRS garnished her wages, placed a lien on her pre-marital real estate and levied her bank accounts. Her husband told her it was a mistake and “not to worry”.

How can you be protected?

Both the Internal Revenue Service and the State of Illinois recognize that there are innocent spouses who:

  1. Filed a joint income tax return not knowing the guilty spouse failed to report on the income tax returns, gross income, deducted improper deductions, or took improper tax credits.
  2. The innocent spouse, like a reasonable person in a similar circumstance, would have not known of the under reporting. The government will consider the innocent spouse’s education, business experience, the nature of the under reporting and the individual’s financial condition.

The government recognizes that innocent spouses must be protected and has established procedures where an innocent spouse can be freed from financial pitfalls orchestrated by the guilty spouse’s tax trap. In evaluating an innocent spouse claim the government will consider the benefit the innocent spouse received and whether the spouses are separated or divorced. As the Forensic CPA who examines the spouse’s business for possible hidden income or assets, I will recommend at times to the innocent spouse that filing a separate tax return rather than a joint tax return may be financially safer.

An agreement drafted by the attorneys where the guilty spouse agrees to pay all tax liabilities should the Internal Revenue Service determine that there is income tax liability is not considered binding by the IRS and affords the innocent spouse little protection.

My experience is that if an innocent spouse presents a well documented case the government will consider the granting of innocent spouse protection. In the case I used as an example, it took several months but eventually I was able to get the woman’s money returned and her property freed of the liens. Had she listened to her now ex-husband, she would have been penniless, chasing after her ex-husband with no financial resources to pay an attorney.

The lesson is: if you are in a shaky marriage and you believe that your husband or soon to be ex-husband is improperly reporting his taxable income from his business, DO NOT SIGN a joint tax return.

CJBS, LLC is a Chicago based firm that assists its clients with a wide range of accounting and financial issues, protecting and expanding the value of mid-size companies. E-mail me at larry@cjbs.com if you have any questions about this posting or if I may be of assistance in any way.

Will You Be Paying More Tax on Similar or Less Income?

by Michael W. Blitstein, CPA 

Most taxpayers would agree that paying more tax on similar or less income does not sound appealing.  The health care reform package (the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010) imposes a new 3.8 percent Medicare contribution tax on the net investment income of higher-income individuals. Although this tax has a wide reach, certain steps may be taken to lessen its impact.

Net investment income. Net investment income, for purposes of the new 3.8 percent Medicare tax, includes interest, dividends, annuities, royalties and rents and other gross income attributable to a passive activity. Gains from the sale of property that is not used in an active business and income from the investment of working capital are treated as investment income as well. However, the tax does not apply to nontaxable income, such as tax-exempt interest or veterans’ benefits. Further, an individual’s capital gains income – both long-term and short-term – will be subject to the tax. This includes gain from the sale of a principal residence, unless the gain is excluded from income under Code Section 121, and gains from the sale of a vacation home. Planning the sale of “big ticket items”, therefore, now often requires attention to the new 3.8 percent surtax.

The tax also applies to estates and trusts, on the lesser of undistributed net income or the excess of the trust/estate adjusted gross income (AGI) over the threshold amount ($11,200) for the highest tax bracket for trusts and estates, and to investment income they distribute. Use of family trusts and other trust-based strategies now must factor in the 3.8 percent surtax in the construction and operation of the trust.  Executors must also be aware of how the 3.8 percent surtax is applied against income on assets held by the estate rather than immediately distributed.

Deductions. Net investment income for purposes of the new 3.8 percent tax is gross income or net gain, reduced by deductions that are “properly allocable” to the income or gain. This is a key term that the Treasury Department expects to address in future guidance. For passively-managed real property, allocable expenses will still include depreciation and operating expenses. Indirect expenses such as tax preparation fees may also qualify.

For capital gain property, this formula puts a premium on keeping tabs on amounts that increase your property’s basis. It also puts the focus on investment expenses that may reduce net gains: interest on loans to purchase investments, investment counsel and advice, and fees to collect income. Other costs, such as brokers’ fees, may increase basis or reduce the amount realized from an investment.

Thresholds and impact. The tax applies to the lesser of net investment income or modified AGI above $200,000 for individuals and heads of household, $250,000 for joint filers and surviving spouses, and $125,000 for married filing separately.

The tax can have a substantial impact if you have income above the specified thresholds. Also, remember that, in addition to the tax on investment income, you may also face other tax increases that have taken effect beginning in 2013. The top marginal income tax rate is now 39.6 percent and the top tax rate on long-term capital gains has increased from 15 percent to 20 percent. Thus, the cumulative rate on capital gains for someone in the highest rate bracket has increased to 23.8 percent. Moreover, the 3.8 percent surtax’s thresholds are not indexed for inflation, so a greater number of taxpayers may be affected as time elapses.

Exceptions. Certain items and taxpayers are not subject to the 3.8 percent tax. A significant exception applies to distributions from qualified plans, 401(k) plans, tax-sheltered annuities, individual retirement accounts (IRAs), and eligible deferred compensation plans. At the present time, however, there is no exception for distributions from nonqualified deferred compensation plans, although some experts claim that not carving out such an exception was a Congressional oversight that should be rectified by an amendment to the law.

The exception for distributions from retirement plans suggests that potentially taxed investors may want to shift wages and investments to retirement plans such as 401(k) plans, 403(b) annuities, and IRAs. Increasing contributions will reduce income and may help you stay below the applicable thresholds. Business owners may want to set up retirement plans, especially 401(k) plans, if they have not yet established a plan, and should consider increasing their contributions to existing plans.

Prudent planning is necessary to create and implement efficient and effective tax strategies that will allow for goals and objectives to be met.  The new 3.8 percent Medicare contribution tax on the net investment income is no exception.  Please seek the advice from your tax professional to determine how this affects you.

CJBS, LLC is a Chicago based firm that assists its clients with a wide range of accounting and financial issues, protecting and expanding the value of mid-size companies. E-mail me at michael@cjbs.com if you have any questions about this posting or if I may be of assistance in any way.

www.cjbs.com