Tax Legislation gets us Past the Fiscal Cliff - for Now
Understand "Sunk Costs" in Making Business Decisions
Use Adjusted Tax Numbers in Your 2013 Planning
Business Effects of American Taxpayer Relief Act of 2012
Individual Effects of the American Taxpayer Relief Act

The American Taxpayer Relief Act of 2012 approved by Congress just after we plunged over the "fiscal cliff" restores and modifies several expired tax breaks, but doesn't address other issues. Here are the highlights of the new law's provisions for individual taxpayers.

Individual income taxes. Only the wealthiest taxpayers face an income tax increase in 2013. A new individual tax rate of 39.6% will apply to single filers with income above $400,000 and joint filers with income above $450,000. Otherwise, the 2012 tax rate structure is permanently extended. However, beginning in 2013, a new 3.8% Medicare surtax authorized by the 2010 health care law also applies to certain high-income investors.

Capital gains and dividends. Under prior law, the maximum tax rate for net long-term capital gain would have been boosted to 20%, while qualified dividends were scheduled to be taxed at ordinary i ncome rates, beginning in 2013. The new law extends the favorable 15% tax rate for most taxpayers and extends the zero tax rate for those in the 10% and 15% brackets for ordinary income. However, for single filers with income above $400,000 and joint filers with income above $450,000, the maximum tax rate on long-term gains and qualified dividends increases to 20%.

Alternative minimum tax. Retroactive to January 1, 2012, the new tax law permanently revamps the alternative minimum tax (AMT) to avoid increased exposure to this "stealth tax." Without the latest fix, an estimated 30 million more filers would have been required to pay the AMT for the 2012 tax year.

Payroll tax holiday. The 2% reduction in payroll taxes ends. Employees will pay a 6.2% social security tax instead of the 2012 rate of 4.2%. Similarly, the social security tax rate for self-employed individuals reverts to 12.4% from 10.4%.

Itemized deductions and personal exemptions. Restrictions are imposed on high-income taxpayers with income above a specified threshold. For single filers with adjusted gross income (AGI) above $250,000 and joint filers with income above $300,000, certain itemized deductions are reduced by 3% above the threshold, but the overall reduction can't exceed 80%. Personal exemptions are phased out above the same AGI thresholds without the 80% cap.

Tax extensions. The new law generally extends, for varying time periods and with certain modifications, several favorable provisions that had expired. The list includes the child, dependent care, adoption, and earned income credits; tax relief from the "marriage penalty"; the American Opportunity Tax Credit for higher education expenses; the deduction for tuition and related fees; the optional state sales tax deduction; the enhanced deduction for student loan interest; the $250 deduction for an educator's classroom expenses; energy credits for qualified home improvements; a conservation donation tax benefit; and the tax-free IRA-to-charity contribution of assets up to $100,000 for taxpayers age 70 and older.

Estate and gift taxes. The new law avoids drastic changes for several provisions that had officially ended after 2012. Significantly, the estate tax exemption, which had been scheduled to drop to $1 million from $5 million (inflation-indexed to $5.12 million in 2012) remains at $5 million with inflation indexing. Portability of exemptions between spouses is preserved. The top estate tax rate, which had been scheduled to increase from 35% to 55% in 2013, is bumped up to 40%. The estate and gift tax changes are permanent.

Other provisions. The new law also temporarily preserves several tax breaks for businesses- including the research credit, the enhanced work opportunity tax credit, a higher Section 179 deduction, 50% bonus depreciation and faster write-offs for qualified leasehold improvements - as well as extending unemployment benefits and higher payments to Medicare providers.

This latest tax law is not likely to be the final word on taxes in 2013. Congress is once again talking about a complete revision of the tax code. Also, the spending side of the "fiscal cliff" issue is yet to be dealt with. Stay tuned for ongoing changes that could affect your personal and business tax planning.

Emotions add zest to life. They propel us to our feet when our favorite running back scores a touchdown. They warm us at an inspirational concert or movie. But in the realm of business, emotions sometimes hinder good choices. In fact, business owners and managers often let emotions dominate the decision- making process.

This is especially true when choices are based on "sunk costs." Broadly defined, sunk costs are past expenses that are irrelevant to current decisions. For example, many firms hire consultants who sell and install software. In some cases, a company is still waiting - three or four years into the contract term - for a functional and error-free system. Meanwhile, costs continue to escalate. But are those costs relevant? Managers, especially those who initially procured the software and contractor, may reason that pulling the plug on a failed contract would be "wasting all that money we've spent."

Not true. That money is "sunk"; it's beside the point. Deciding to continue with a non-performing contract instead of staunching the flow of cash and changing course is irrational. It may be difficult to admit that a mistake was made. It may bruise the ego of the decision maker. But abandoning a failed contract is often the wisest decision. The only relevant costs are those that influence the company's current and future operations.

Irrelevant costs
Let's say your firm hires a new salesman. You spend thousands of dollars sending him to training seminars. You assign mentors who take time from their busy schedules to provide on-the-job coaching and oversight. But despite your best efforts, the new hire isn't working out. He doesn't fit your firm's culture; he doesn't grasp the company's goals and procedures; he doesn't generate adequate revenues for the business.

As a manager, what should you do? At some point, you may need to terminate that employee and start over with someone else. But what about all that time and money you spent training and mentoring the new salesman? Those costs are irrelevant; they're "sunk." You can't get them back. So the best decision - as of today - may involve cutting your losses and starting anew.

Other examples of sunk costs may be found in the areas of product research, advertising, inventory, equipment, investments, and other types of business expenses.

The IRS and the Social Security Administration have published some inflation-adjusted numbers for 2013. Use these numbers as you begin your tax and financial planning for 2013.

Social security taxable wage limit for 2013 will be $113,700. Retirees under full retirement age can earn up to $15,120 without losing benefits.

The threshold for unearned income a child can earn in 2013 without having the kiddie tax apply is $2,000.

The amount that can be given each year without paying gift tax is $14,000 ($28,000 for joint gifts).

The amount that can be set aside in a health savings account is limited to $3,250 for individuals and $6,450 for families. Those 55 or older can contribute an additional $1,000.

The maximum salary deferral for a 401(k) increases in 2013 to $17,500. The catch-up limit for those 50 or older remains unchanged at $5,500.

The maximum IRA contribution limit increases to $5,500; the limit for those 50 or older is $6,500.

The maximum salary deferral for SIMPLEs increases in 2013 to $12,000. The catch-up limit for those 50 or older remains unchanged at $2,500.

Contact our office if you have questions or wish to discuss early 2013 tax planning.

Although Congress averted many of the consequences of a possible tumble over the fiscal cliff with last-minute action, you should be aware of the potential impact on your business of the American Taxpayer Relief Act of 2012. We encourage you to review the highlights of the new law below and call us if you have any concerns about how your tax situation will change as we prepare your returns for this filing season.

Several popular business tax provisions were set to expire at the end of 2012. For example, small business expensing under Internal Revenue Code Section 179 was increased retroactive to Jan. 1, 2012, and extended through 2013. The dollar limit that can be expensed in 2012 and 2013 is $500,000 and there is a $2 million investment limit. You also can make use of the 15-year recovery period for qualified leasehold improvements, retail improvements and restaurant property until the end of 2013.

Many other business tax benefits that had expired or were set to expire were extended through 2013, including:

• The 50% bonus depreciation
• The Section 41 research tax credit
• The Work Opportunity Tax Credit for hiring veterans and other individuals who meet specific criteria
• The 100% exclusion for gains on a sale of small business stock
• Special tax incentives for businesses located in empowerment zones
• Rules on S corporations making charitable donations of property

Of course, small business owners will also be affected by many of the provisions of the law governing individuals. For example:

• Taxpayers will pay a new 39.6% rate on individual incomes of more than $400,000 and on incomes of more than $450,000 for married taxpayers filing jointly. All other existing rates remain the same. The income you receive from a partnership or S corporation will be subject to rates as high as 39.6%. Corporate income for C corporations remains at 35%, which means it may be worthwhile to evaluate a change in the form of your business to avoid the highest individual rate.
• The same individuals who are subject to the new 39.6% top rate on income face a 20% rate on capital gains and dividends, up from 15%.
• The phase-out levels for personal exemptions and itemized deductions are raised to $300,000 for married couples and surviving spouses and $250,000 for individuals.
• After years of late-year alternative minimum tax "patches," the new law permanently indexes the AMT to inflation.
• The law did not extend the 2% cut for the employees' portion of the Social Security payroll tax, which means it reverts to 6.2% on income up to $113,700 in 2013.
• After years of uncertainty, the new law holds the estate and gift tax exclusion at $5 million, indexed for inflation ($5.12 million in 2012). The top tax rate jumped to 40% from 35% as of Jan. 1, 2013. Without this change, it would have soared to 55% and estates worth over $1 million would be subject to that rate. The act also made permanent the estate tax portability election, which allows a surviving spouse to use a deceased spouse's unused exemption amount.
• Business owners struggling to pay their home mortgages - or whose home values have fallen below t heir purchase price - get another year of tax relief on any "indebtedness income" they may receive as a result of a loan modification or short sale.

Also, some taxpayers who have net investment income face a 3.8% surtax on categories of certain investment income, potentially increasing their top rate to 43.4%. This tax already was slated to go into effect as a result of health care reform.

These are just a few of the most important provisions of the new law. We can help you understand the effect that these and other changes will have on your tax situation.

In addition to preparing your return in a way that maximizes tax advantages for your business, we are available after tax season to advise you on strategies and planning decisions that will help minimize taxes and meet your financial goals. Planning is particularly important because the law preserved several popular provisions that are set to expire at the end of this year.

Please don't hesitate to contact us today at 760-765-0343 to schedule an appointment to begin discussing your options.

Although Congress averted many of the consequences of a possible tumble over the fiscal cliff with last-minute action, we would like you to be aware of the impact of the bill that was passed - known as the American Taxpayer Relief Act of 2012 - signed into law Jan. 2.

We have compiled an overview of the key provisions of this new law. We encourage you to review them and call us if you have any concerns about how your tax situation will change as we prepare your returns for this filing season.

A Tax Increase on the Highest Incomes in 2013. Although most taxpayers avoided a tax increase, rates did rise for top earners. Taxpayers (including those who receive income through partnerships and S corporations) who earn more than $400,000 ($450,000 for married taxpayers filing jointly) have a marginal tax rate of 39.6%. All other existing rates remain the same.

Higher Capital Gains Rates for Top Earners. The same individuals who are subject to the new 39.6% top rate on income now face a 20% rate on capital gains and dividends, up from 15%. Taxpayers in the 10% and 15% income brackets have a zero capital gains rate and those in the middle will continue to pay 15%.

Higher Personal Exemptions Phase-out Levels. The phase-out levels for personal exemptions and itemized deduction have been raised to $300,000 for married couples and surviving spouses and $250,000 for individuals.

Permanent AMT Inflation Indexing. The alternative minimum tax originally was intended to prevent high-income individuals from avoiding taxes. In the absence of a patch for last year, more than 60 million middle-income taxpayers might have been subject to the AMT on their 2012 income. After years of last- minute AMT "patches," the new law permanently indexes the AMT to inflation starting in tax year 2012. For income you earned in 2012, the exemptions are $50,600 for individuals and $78,750 for married taxpayers filing jointly.

Restoration of the Full Rate for Social Security and Medicare Taxes.The law did not extend the 2% cut for the employees' portion of the Social Security payroll tax, which means it will go back to the full rate of 6. 2% on income up to $113,700 in 2013.

Clarity on Estate and Gift Taxes.After years of uncertainty in this area, the new law holds the estate and gift-tax exclusion at $5 million, indexed for inflation ($5.12 million in 2012). The top tax rate jumped to 40% from 35% as of Jan. 1, 2013, but without this change, it would have soared to 55% with a $1 million exclusion amount. The act made permanent the estate tax portability election, which allows a surviving spouse to use a deceased spouse's unused exemption amount.

Marriage Penalty Relief Retained. Certain taxpayers filing jointly will no longer have to worry about paying more than if they filed as single taxpayers; joint filers also will enjoy a larger standard deduction.

Education Tax Benefits Extended. Many deductions for education expenses were set to expire at the end of last year, but they will remain in place under the new law. For example, the law extends the deduction f or qualified education expenses through 2013 and retroactively for the 2012 tax year.

Conversions to Roth Retirement Plans. The new law allows participants in an employer-sponsored 401(k) to transfer any amount to a Roth 401(k) - the funds will be taxed upon conversion.

Tax Relief for Mortgage Loan Modifications. Taxpayers struggling to pay their mortgages, or whose home values have fallen below their purchase price, were given another year of tax relief on any qualifying "indebtedness income" they may receive as a result of a loan modification or short sale on their principal residence.

Also, taxpayers who have net investment income beginning in 2013 will face a 3.8% surtax on categories of certain unearned income, potentially increasing the total tax rate to 43.4%. This tax was already slated to go into effect as a result of health care reform.

We can help you understand the effect that these changes will have on your tax situation. In addition to preparing your return in a way that maximizes your tax advantages, we are also available after tax season to advise on strategies and planning decisions that will help you minimize taxes and meet your financial goals.

Please don't hesitate to contact us today at 760-765-0343 to schedule an appointment to begin discussing your options.