Thursday, October 24, 2013

Health Care Reform Raises Rates and Reduces Exemptions

Effective for 2013, new rules have increased taxes or reduced exemptions on higher earning taxpayers, making effective year-end tax planning even more important.

Under the Affordable Care Act there is a higher payroll tax and surtax on unearned income of higher-income individuals. Under the American Taxpayer Relief Act of 2012 higher tax rates apply to ordinary income, capital gains and dividends, while at the same time limitations are imposed on the use of the personal exemption and itemized deductions.

For tax years beginning after Dec. 31, 2012, the following new rules apply:
  • Increased payroll tax.  A new 0.9% hospital insurance tax (FICA payroll tax) applies to wages received in excess of $250,000 for joint returns; $125,000 for married filing separate; and $200,000 for all other taxpayers. The additional 0.9% tax also applies to self-employment income that meets or exceeds the above thresholds.
  • Surtax on unearned income. An unearned income Medicare contribution tax is imposed on individuals, estates, and trusts. For an individual, the tax is 3.8% of the lesser of (1) net investment income or (2) the excess of modified adjusted gross income over $250,000 for a joint return or surviving spouse, $125,000 for married filing separate, and $200,000 for all others.
  • Higher individual income tax rates. The income tax rates for most individuals stay the same as in 2012. However, a new 39.6% rate applies for 2013 income above $450,000 for joint filers and surviving spouses; $425,000 for heads of household; $400,000 for single filers; and $225,000 for married filing separately.
  • Increased capital gain and dividend tax rates. The top 2013 tax rate for capital gains and dividends rises to 20% for taxpayers with incomes exceeding $450,000 for joint filers and surviving spouses; $425,000 for heads of household; $400,000 for single filers; and $225,000 for married filing separately.
  • Personal exemption phase out. There is a personal exemption phase out  for 2013 with a beginning threshold of $300,000 for joint filers and surviving spouses; $275,000 for heads of household; $250,000 for single filers; and $150,000 for married filing separately. Under the phase out, the total amount of exemptions that can be claimed by a taxpayer is reduced by 2% for each $2,500 (or portion thereof) by which the taxpayer's adjusted gross income exceeds the above threshold.
  • Limited itemized deductions for high earners. There is a limit on itemized deductions for 2013 for earners with a threshold of $300,000 for joint filers and surviving spouses; $275,000 for heads of household; $250,000 for single filers; and $150,000 for married filing separately. Thus, the itemized deductions of taxpayers subject to this limitation will be reduced by 3% of the amount by which their adjusted gross income exceeds the threshold amount. The reduction will not exceed 80% of otherwise allowable itemized deductions..
Year-end tax planning may be especially productive this year because timely action by the taxpayer could secure significant tax breaks.

Tuesday, October 8, 2013

Bankrupt Local Governments

Local governments of all sizes are facing significant budget deficits and have been for years. These deficiencies have eroded municipalities’ ability to pay their debts. As a result some municipalities have resorted to filing for bankruptcy protection under Chapter 9, Title 11, of the United States Code. Chapter 9 is available exclusively to municipalities to assist them in restructuring their debts. Most recently the city of Detroit, Michigan took advantage of Chapter 9 and became the largest municipal bankruptcy in U.S. history with debts totaling over $18 billion. Detroit replaced Jefferson County Alabama, as the largest municipal bankruptcy with debts of over $4.2 billion.

According to the website Governing, municipal bankruptcy remains relatively rare. A Governing analysis estimated that only one of every 1,668 eligible general-purpose governments (counties and cities) filed for bankruptcy protection over the past five years. One of the reasons for this low level of bankruptcy filings is that states must have in place laws authorizing municipal bankruptcy before a municipality can take advantage of Chapter 9. Only about half of the states have enacted such laws. The state then must approve of the municipality entering bankruptcy. States that have not enacted such laws often have other measures providing financial relief.

The cause of most municipal bankruptcies can frequently be attributed to the accumulation of large amounts of debt, usually from one or more of the following:
  • Unfunded pension liabilities
  • Unfunded health care benefits
  • Mismanagement
  • Over-budget capital projects
  • Reduced state and federal aid
  • Reduced tax revenues
According to the Wall Street Journal, “Detroit’s municipal pension funds awarded retirees, in some years, more than a 20% return on their annuities even as the funds lost value” contributing to the financial crisis. The pension debt has ballooned to nearly one-fifth of the city’s total debt. CNN reported that “Detroit spends roughly 38 percent of its annual budget on these types of ‘legacy’ costs leaving only 62 percent of spending for education, infrastructure, police and firefighters.”

Municipal bankruptcies are handled at the federal level, so constitutional issues prevent the judge from dictating how a municipality is run. Thus, the judge cannot mandate actions such as tax increases, budget cuts, asset sales or the removal of local politicians.

I think that there should be a mandatory requirement for all politicians, including the ones in Washington, D.C., to take, and pass, a course on fundamental accounting before being allowed to take office. It seems that no one understands the basic concept that if you spend more than you take in, year after year, you will eventually end up like the city of Detroit--bankrupt!

What do you think?

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