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.

What do you think?

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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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CRIMINAL ACCOUNTANTS

Embezzlement – The theft or misappropriation of funds placed in one’s trust or belonging to one’s employer.

It seems like all you have to do these days is pick up a newspaper and you will find an article about an embezzlement similar to the following one reported by WFAA.com: “Former Collin Street Bakery accountant accused of embezzling more than $16 million from the renowned fruitcake maker.” What concerns me most about this crime is that the embezzler was the accountant.

The accountant for Collin Street Bakery worked for the company for fifteen years and was a trusted employee. He allegedly spent the last eight of those years embezzling $16.65 million dollars from his employer. The money was used to support an extravagant lifestyle that included 43 luxury automobiles and a house in New Mexico. The person who committed the embezzlement was the employee who understood how the accounting system worked and used that knowledge to cause 888 fraudulent checks to be sent to his personal creditors, according to the FBI.

When I began my accounting career, I pledged to adhere to a Professional Code of Conduct. I also pledged to adhere to my employer’s Code of Business Conduct and Ethics. I take both pledges seriously. Evidentially there are a growing number of accountants who do not feel that codes of conduct apply to them.

In the past few months, I have seen the term embezzlement used too often along with the title “Accountant.” The connection is usually in a newspaper article about an alleged embezzlement committed by an accountant.

Why Are Embezzlements Happening So Often?

According to a survey conducted by the Association of Certified Fraud Examiners (ACFE), instances of fraud are increasing nationwide, both in number of incidents and the dollar amount of the losses.   

Unfortunately this is nothing new. My first audit as a junior auditor forty-five years ago, uncovered an embezzlement of over $75,000 by the accountant. It was not the last audit assignment in which I encountered embezzlement. It may just be better media coverage that has brought this topic to our attention, but it seems to me that embezzlement is more common today than in the past. Maybe it is not just embezzlement. Maybe it is dishonesty in general.

Embezzlements by Accountants

The following examples of embezzlements by accountants in the last five years shows that everyone— Fortune 100 companies, public companies, governmental entities, and small private companies—is susceptible to this crime.

·       Citigroup                                            $19.20  million in losses                   2011

·       Collin Street Bakery                           $16.65  million in losses                   2013

·       South Carolina Education Lottery        $ 226.4 thousand in losses               2012

·       Kemp Construction                            $ 208.0 thousand in losses               2009

In each of these cases, the alleged fraud was perpetrated by a trusted accountant.

How Can these Crimes be Prevented?

Someone once said that “Trust is not an internal control it’s only a feeling.” In all of the examples listed above management or owners of the business trusted their accountant.

Our inherent desire to believe that all of our employees are trustworthy gives us a false sense of security. Add a lack of resources or desire to implement necessary controls and you have a recipe for embezzlement.

The solution to this problem is simple to identify, but often difficult to implement. Separation of duties and implementation or execution of a few internal controls could have prevented or at least reduced the losses in each of the embezzlements listed above. If a company does not have the resources to develop and maintain appropriate internal controls, it is virtually impossible to prevent embezzlement. However, with just a small amount of effort, a company can hold its losses to a minimum.

What do you think?


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The Many Tax Implications of DOMA

The Supreme Court’s decision to strike down the definition of “marriage” as defined in the Defense of Marriage Act (DOMA) is going to have far-reaching tax implications for married same-sex couples. The decision makes it clear that the federal government must recognize a lawful same-sex marriage. However, it left many unanswered questions. Following are just some of those questions:

1. Will the court’s decision be applied retroactively, and if so, to what extent?

2. Since some federal benefits are determined by place of residence, what is the effect on same-sex married couples who marry in one of the states where same-sex marriage is legal, but later relocate to one of the states where it is not legal?

3. Will same-sex married couples be permitted to amend their tax returns for prior years?

4. What if a couple is married in a state that recognizes same-sex marriage, but at December 31, 2013, the couple lives in a state that does not recognize same-sex marriage? Can they file a joint return for 2013?

5. What about decisions made based on filing status that are now too late to correct, such as Roth IRA contributions?

6. Will individuals who filed for automatic extensions for the 2012 tax year have guidance available in time to meet the October 15, 2013, extended deadline?

7. Will the court’s opinion affect same-sex couples in states that sanction domestic partnerships or civil unions?

8. What is the impact on employers with operations in multiple states? Can they apply a single standard or must they apply each state’s rules?

9. Are same-sex spouses entitled to all the survivorship rights given traditional married couples under a tax-qualified retirement plan?

10. Spouses who had health-care coverage, through their employer, for their same-sex partners were taxed on those benefits. Can prior year(s) tax returns be amended to reduce income by those amounts in order to have the tax refunded?

11. Employee Benefit Cafeteria plans can, but are not required to, permit mid-year election changes for certain events. If a plan permits mid-year election changes in connection with the marriage of opposite-sex couples does it have to allow the same change for same-sex couples?

12. What if an employer is based in a state that does not recognize same-sex marriages but has an employee who marries a same-sex partner in a state that does? Which state’s definition of marriage will apply?

And the list goes on.

Same-Sex marriage is legal in 13 states and the District of Columbia but is not legal in the other 37 states. Historically the IRS has deferred to states’ definition of marriage when applying federal tax rules. However if the IRS keeps the state residency policy, then the people in the 37 states where same-sex marriage is not expressly endorsed have gained virtually nothing, tax wise, from the Supreme Court’s decision.

With over an estimated 1,000 federal statutes that now need to be evaluated, and possibly amended to bring them into compliance with the new definition of marriage, looks like Congress will have plenty to keep them busy for years to come.

What do you think?

NEW webinar: The Next Step for DOMA: Implications and Opportunities
This webinar explores the key tax effects of the decision, including filing status, amended returns and protective refund claims, divorce and community property issues, and estate and gift tax planning opportunities. 2 CPE credits. More information.

DOMA Ruling Explained

On June 26, 2013 the Supreme Court ruled the Defense of Marriage (DOMA) act unconstitutional in a 5-4 decision. Specifically, the court struck down section 3 of the act which defines “marriage” as a legal union between one man and one woman and “spouse” as a person of the opposite sex who is a husband or wife. Upon repeal of DOMA, the federal government will now recognize all legal same sex unions in states that allow same sex unions. This aspect of the ruling is quite clear. 

What is not yet clear is the implication this will have on federal tax law and the affect this ruling will have on same sex couples immediately and moving forward. In some ways, this ruling will simplify tax law: same sex couples filing jointly in their state will now be able to file jointly with the federal government as well. Some aspects of the law are less simple and will require further clarification from the IRS as time passes.

Details of the Ruling

Traditionally, the regulation of marriage is an authority granted to the separate states. There are some examples where federal law regulates marriage in order to further federal policy, but generally the federal government seeks to limit the implications of these exceptions. The Supreme Court deemed DOMA §3 unconstitutional because of the far reaching implications of the provision—it affected over 1,000 federal statutes and many regulations.

Furthermore, rather than promote consistency, DOMA treated married couples within the same state differently, imposing restrictions, stigma and disabilities onto a state defined class. Those judges striking DOMA were concerned with the equal protection issues and they argued that the law makes unequal a subset of state-sanctioned marriages in areas ranging from taxes to Social Security and veterans' benefits. It is important to note that the scope of this ruling is confined to only “lawful marriages.”

Immediate Tax Implications

The following are among the tax breaks newly available to legally married same-sex couples:

... the right to file a joint return;

... the opportunity to get tax-free employer health coverage for the same-sex spouse;

... the opportunity for either spouse to utilize the marital deduction to transfer unlimited amounts during life to the other spouse, free of gift tax;

... the opportunity for the estate of the first spouse to die to get a marital deduction for amounts transferred to the surviving spouse;

... the opportunity for the estate of the first spouse to die to transfer the deceased spouse's unused exclusion amount to the surviving spouse;

... the opportunity to consent to make "split" gifts (i.e., gifts to others treated as if made one-half by each); and

... the opportunity for a surviving spouse to stretch out distributions from a qualified retirement plan or IRA after the death of the first spouse under more favorable rules than apply for nonspousal beneficiaries.

Many other tax provisions are affected by a taxpayer's marriage status, such as the deductibility of alimony paid to a spouse or former spouse and the availability of the innocent spouse protections.

Planning Tips

Married same-sex couples who filed separate federal returns due to DOMA should consider filing amended returns with claims for refund, where applicable. Filing jointly may produce a lower combined tax than the total tax paid by the same-sex spouses filing as single persons, but this can also produce a higher tax, especially if both spouses are relatively high earners. Tax professionals should calculate for their same sex couple clients their past returns to determine if an amended return will result in a refund.

Married same-sex couples should also amend their estate plans to take advantage of many of the favorable provisions listed above. It is estimated that there are more than 100,000 same sex marriages in the USA. This means that as many as 300,000 amended returns could potentially be required in the near future. Tax professionals should consider filing protective claims for tax returns for which the statute may be about to expire.

Areas for Further Exploration

Because the recent ruling limits its scope to “lawful marriages” it is yet to be seen how the federal government will handle domestic partnerships and civil unions of same sex couples. It is possible that the current ruling will only affect those couples living in states where same sex marriage is legal.

Additionally, the Supreme Court did not strike down section 2 of DOMA which allows states to refuse to recognize same sex marriages performed in other states. Because of this, a couple may be legally married in one state, but living in a state that does not recognize their marriage as valid. It is yet to be seen how the government will view these marriages on a federal level.

Tax professionals will have to wait for the IRS to issues procedures for dealing with these complicated situations.

The Gear Up Editorial Team

Revisions to the Indoor Tanning Services Excise Tax

The excise tax for indoor tanning services has been around since 2010 as part of the Patient Protection and Affordable Care Act. This tax is the government’s way of trying to get you to stop using indoor tanning services, since using them may cause skin cancer.

This is an example of the U.S. government again enacting legislation in an attempt to influence the choices we make. They learned from Prohibition that outlawing an activity often has little effect on our choices so they opted for the next best thing—they taxed it.

The Internal Revenue Service has revised and finalized the regulations for the 10% excise tax on Indoor Tanning Services (ITS) imposed by this legislation. The temporary regulations, effective July 1, 2010, were revised by the 2013 final version. The final regulations are effective as of June 11, 2013; however, there could be additional revisions in the future.

Some of the 2010 temporary regulations were retained while others were revised or superseded by the 2013 final regulations. Following is a summary of some of the more significant items that changed and those that have stayed the same.

Qualified Physical Fitness Facilities (QPFF)

1. Certain QPFFs, with membership fees that include access to indoor tanning facilities, were exempted from the excise tax by the 2010 regulations even though the QPFFs provide basically the same indoor tanning services as non QPFFs.

2. The 2010 regulations limit the definition of a QPFF to a business that does not charge separately for its ITS, offer ITS to the general public, or offer different membership rates based on access to the ITS. If the business meets all three conditions it is exempted from the tax.

3. The 2013 regulations maintained this exemption despite complaints that the exemption creates an unfair competitive advantage for exempt QPFFs.

Free or Discounted Indoor Tanning Services (ITS)

1. The final 2013 regulations specify that the tax only applies if an amount is paid for ITS.

2. If services are provided at a reduced rate, the tax applies to the amount actually charged for the tanning services.

3. The 2013 regulations specify that the tax does not apply to ITS received for redemption of “bonus points” from a loyalty or similar program.

4. For promotions that include a “free” tan with the purchase of a specific number of tans the purchased tans are considered as a reduction to the price of all of the tans rather than a package of purchased tans at full price along with a “free” tan. The tax is applied to the purchase of the package of tans rather than the redemption of the additional tan.

Bundled Services

1. The 2010 regulations provided a formula to determine the amount reasonably attributable to ITS included in a bundle of services. The 2013 regulations leave the bundled rules intact.

2. If the ITS are bundled with other goods and services, the provider must manually calculate the amount of the payment for the bundled services that is attributable to ITS.

3. The final 2013 regulations authorize the Treasury Department and the IRS to issue future guidance to identify additional options for making this calculation.

Gift Cards

1. An undesignated payment card is defined by the 2010 temporary regulations as an item that can be redeemed for goods or services that may or may not include ITS.

2. The 2010 temporary regulations imposed an excise tax only when the card is redeemed for ITS, not when it is purchased. It was pointed out that a provider can only collect the tax when the card is purchased not when it is redeemed for ITS.

3. The 2013 regulations do not change the 2010 requirements however, they authorize the Treasury Department and the IRS to issue future guidance with respect to undesignated payment cards.

4. As required by the 2010 temporary regulations the excise tax must be reported and paid quarterly on Form 720 “Quarterly Federal Excise Tax Return.”

Membership and Enrollment Fees

1. The 2013 final regulations clarify that the excise tax on ITS is imposed on amounts paid for monthly membership and enrollment fees to a provider of ITS, other than a qualified QPFF, even if the member does not use any ITS’s during the period to which the fees relate.

2. Some providers charge a fee that allows the member to skip one or more months of membership dues without being charged an enrollment fee when they restart their monthly membership. Amounts paid to temporarily suspend a periodic membership program are considered amounts paid for ITS and are subject to the excise tax.

The government has taxed alcohol, cigarettes and now indoor tanning services to try to legislate good health practices. I don’t think that they have been very successful with either alcohol or cigarettes and they probably won’t be very successful with indoor tanning services either. What do you think?



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Three Strikes for the RTRP Regulations?

In baseball it is three strikes and you are out, but what about lawsuits? Three individuals sued the IRS to stop them from implementing their new regulatory scheme for registered tax return preparers (RTRP). Following is the course of events.

January 18, 2013 – As the result of the lawsuit, Federal District Judge James E. Boasberg issued an injunction preventing the IRS from enforcing its new Registered Tax Return Preparer regulations. (Strike 1) The IRS then filed a motion to stay the injunction.


February 1, 2013 – Judge Boasberg denied the IRS’s motion to stay. (Strike 2) The court also went on to clarify the requirements of the injunction and to emphasize that the PTIN (preparer tax identification number) program was specifically authorized by Congress and therefore not covered by the judge’s ruling.


March 27, 2013 – The District of Columbia Circuit Court of Appeals denied the IRS’s request to suspend the January 18th injunction. (Strike 3) A three judge panel upheld Judge Boasberg’s refusal to lift the injunction against the IRS. The court found that the IRS had not satisfied the strict requirements for a stay pending appeal.


The next major step will be a merits briefing which will conclude with oral arguments before a three-judge panel of the District of Columbia Circuit Court of Appeals.


Judge Boasberg did clarify that tax preparers could take competency tests and continuing education courses but only on a voluntary basis while his injunction remained in place.


Has the IRS struck out with its RTRP regulations? Probably not, but it may take an act of Congress to accomplish their goal of licensing all tax return preparers who are not EAs, CPAs, or Attorneys.


What do you think?