TAX UPDATES – AUGUST 2009
The season for tax updates has arrived, but this year the updates have been arriving continually rather than at the latter part of the year. There has been so much conjecture and speculation, but as always we post these changes and updates when they become law. We will update you on PENDING changes if they are significant, but when you read something that is PENDING please know that nothing is final until the bill is signed into law.
CHANGES FOR 2009 AND 2010
Roth IRAs: Effective January 1, 2010, high income earners will get access to Roth IRAs. Currently, you can convert a traditional IRA to a Roth IRA only if you have AGI of $100,000 or less. The phase-out for contributions begins at $166,000 and is completely phased out at $176,000, whereas the phase-out for singles begins at $110,000 and is completely phased out at $120,000. TIPRA repealed the AGI limitation on conversions, but the law change doesn’t take effect until January 1, 2010. There are several tax planning strategies here, so if you are interested in exploring them, please contact us!
Education Credits: Effective for 2009 and 2010 only, the American Opportunity tax credit (formerly known as the Hope Scholarship credit) increases to $2,500 and extends to all four years of a college-degree program study. Also, 40% of the credit is refundable. The start of the phase-out is now pushed to $160,000 for joint filers and $80,000 for single filers. (NOTE: The phase-out for the Lifetime Learning credit remains the same.) As in years past, in lieu of either credit the taxpayer can claim the tuition deduction of $4,000 if AGI is below $130,000 for joint filers and below $65,000 for single filers. The deduction is reduced to $2,000 for AGI up to $160,000 for joint filers and $80,000 for single filers. We explore both options for our clients and always prepare the tax returns using the greater allowable benefit, pursuant to IRS guidelines.
Energy Credits: For those clients who are interested in going “green”, the recent tax law changes increased the credit for installing a solar heating system from 10% to 30%. In addition, the dollar limitations on residential energy property expenditures have been eliminated and will be eligible for the 30% credit if they were previously eligible for the $50, $150 and $300 credits. Lastly, the $500 lifetime cap ($200 for windows) is eliminated and replaced with an aggregate $1,500 cap for 2009 and 2010. The credit is extended through December 31, 2010.
First Time Homebuyer Credit: The $8,000 credit for first-time homebuyers will expire soon – November 30, 2009 is the last day.
Child Tax Credit: For lower income earners, the child tax credit has been expanded by reducing the threshold of income where the taxpayer is eligible for the credit. For example, under previous law a family with two children didn’t qualify for the full credit of $1,000 per child unless it had earnings of at least $21,833. Under new law, that same family would qualify for the full credit when earnings reach $16,333. It’s estimated that 2.9 million more children will qualify for the credit under the new law.
529 Plan: Under previous law, the cost of a computer purchased for a student didn’t qualify as an eligible expense unless the computer was required by the college or a specific degree program or course. Under new law, money from a 529 plan can be used to purchase computers and related technology. This includes the purchase of internet access and related services. This change applies to 2009 and 2010 only.
Unemployment Compensation Exclusion: New law provides a suspension of federal income tax on the first $2,400 of unemployment benefits received by a recipient in 2009.
Tax Rates and Business Formation: As the odds of tax rate increases on high income taxpayers improve, it provides us the opportunity to more closely examine the tax attributes of setting up your small business. The top rate for both individuals and C-Corporations, as of now, is 35%. This keeps individuals who report S-Corporation earnings on their tax returns on the same playing field as C-Corporations. However, the top individual tax rate will likely top 40% after 2010, and if you factor in the potential surtax of 5%, then the top rate could be more like 45%. The higher rates could provide more incentive to look at C-Corporations again, even though there is a second layer of income tax on any dividends paid and at liquidation. If this spread continues, then it could be that S-Corporations, partnerships, and sole proprietorships would become less attractive to business owners. This breaks a 20-plus year trend of the opposite being true, when in 1986 the top individual rate slipped below the max rate of corporations. Stay tuned…..
Social Security Wage Base Update: The Social Security wage base is expected to remain at $106,800 for 2010, which is the first time in many years that it won’t rise (often called the most overlooked annual tax increase). However, Social Security recipients shouldn’t expect more money in their checks in 2010, either. The actuaries state that there will not be a cost of living adjustment for 2010. No increased pay-in, no increased pay-out…..
New in the Arsenal for Investigating Tax Evaders: Facebook and MySpace! Many states are using social networking as a tool to locate those who choose not to pay taxes. IRS hasn’t committed to use them, but if it works for the states they may change their minds!
Substantiation, Substantiation, Substantiation: I know you guys grow tired of hearing me say this, but please remember that a mileage log or diary is necessary to ensure your automobile use deduction. With the extensive Section 179 deductions, bonus depreciation in place for this year, and even mileage (if you don’t take actual expenses such as Section 179, bonus and regular depreciation), the automobile deductions can be quite large. However, in the event of an IRS examination or audit, the deduction will be lost without substantiation. Please make sure you have it.
Dividend or Second Class of Stock?: This is something that we try to watch for our S-Corporation clients but I think it bears repeating. A recent tax court case saw an S-Corporation making its shareholders’ state tax liability payments. However, the payouts were not made in proportion to ownership, and IRS deemed the payouts to be a prohibited second class of stock. The corporation had to pay IRS for a private letter ruling to avoid losing its S-Corporation election. Please be aware that all dividend distributions must be made in a pro-rata fashion in cases like this.
PENDING AND POTENTIAL CHANGES
IRS is now talking about scaling back the surtax which was promised on higher income earners in earlier pending legislation. With the health care bill stalling, and the surtax funds less critical, it’s looking like the surtax won’t affect incomes under $1 million. We will keep you posted….
There is a pending restriction on the use of Flex Spending Accounts and Health Savings Accounts – no more using the funds for purchases of over-the-counter medications.
There are three stimulus-related items that are set to expire soon: The first-time homebuyer credit of $8,000; the tax exclusion of up to $2,400 in unemployment compensation; and the state sales tax paid on a new auto up to a cost of $49,500. Congress is talking about extending them (all or some, we don’t know) due to the fact that the economy, while improving, is still “fragile.”
Dependent Care Expenses and Flex Spending Accounts: The annual limit for dependent care expenses flex spending accounts has been at $5,000 since 1986. There are proposals that would increase the limit to $7,500 for one child and $10,000 for two or more dependents. This could be a great change for some of our clients, so we will keep you posted.
FUTA Tax Rate in SC: The state of SC is facing the possibility of a higher FUTA tax rate for 2010 due to the outstanding state loan balances. FUTA tax is the federal unemployment tax that is paid by employers for their employees. The current FUTA rate, as you know, is .8% on the first $7,000 paid to each employee. The potential rate increase could move the FUTA tax to 1.1%. This would result in an additional $21 of tax on each employee who is paid at least $7,000 in 2010. SC has until November 2010 to repay its loans or employers will pay the higher FUTA tax.
Health Care Changes: We won’t make any comments due to the instability and ever-changing landscape of health care reform and how it may impact our small businesses. We will keep you posted as anything becomes final. There is so much conjecture and speculation in this area.
As always, we are happy to meet with you to discuss these changes and how they may affect your personal tax returns for 2009. We have already had some productive meetings with clients this year, checking withholding exemptions on pay to ensure that no surprises come up in April, making plans for small businesses, setting up compensation plans for S-Corporation shareholders, exploring options for small business pension plans for owners and employees…..the possibilities are endless! Please let us know if you would like to come in and discuss anything as the fourth quarter approaches. Tax preparation season will be here again before you know it!