Standard mileage rates 2013

Transcription

1 Deducting Business Vehicle Expenses Every time you fill up at the pump, you're reminded that operating a vehicle isn't cheap. Fortunately, there is some relief from the IRS. The table below lists the standard mileage rates for Standard mileage rates 2013 Business miles Miles driven for medical or moving expenses Miles driven in service of a charity 56.5 cents for 2013 (up from 55.5 cents for 2012). 24 cents per mile for 2013 (up from 23 cents in 2012 ). 14 cents for 2013 (unchanged from 2012) Although the standard mileage rate is easier for recordkeeping purposes, you almost always get a larger deduction by keeping track of actual expenses. You can write off the business-use percentage of operating costs such as gasoline, oil, maintenance and insurance. Plus, you can deduct depreciation. To use the actual expense method, you must keep a log to record the time, place, mileage and purpose of each business trip, along with the total mileage for the year. That allows you to calculate the business use percentage. Understanding How the New Medicare Tax Affects Individuals The 2010 healthcare legislation created a new 3.8 percent Medicare tax on net investment income collected by individuals, estates, and trusts. The new tax, which the IRS calls the NIIT, is effective for tax years beginning on or after January 1, So it's now officially time to start planning to avoid or minimize the tax for this year. To do that, you need to understand how it works. Helpfully, the IRS issued proposed regulations that provide much-needed details.

2 Here is the impact of the new tax on: Individual Taxpayers - Taxpayers are exposed to the NIIT when their modified adjusted gross income (MAGI) exceeds certain thresholds. The threshold amounts are $200,000 for unmarried people; $250,000 for married joint-filing couples or qualifying widows and widowers; and $125,000 for those who use married filing separate status. Notes: These thresholds won't be adjusted for inflation, so more individuals will probably be hit with the NIIT in the future. Non-resident aliens are not subject to the NIIT. The amount subject to the NIIT is the lesser of net investment income or the amount by which MAGI exceeds the applicable threshold. For this purpose, MAGI is defined as regular AGI from the bottom of page 1 of your Form 1040 plus certain excluded foreign-source income of U.S. citizens and residents living abroad net of certain deductions and exclusions. Trusts and Estates - Trusts and estates are also exposed to the NIIT. Specifically, the NIIT applies to the lesser of the trust or estate's undistributed net investment income or AGI in excess of the threshold for the top trust federal income tax bracket. For 2013, that threshold is only $11,950, so many trusts and estates will probably owe the tax this year. Estimated Taxes - If the 3.8 percent NIIT is owed, it should be taken into account for quarterly estimated tax payment purposes to avoid the interest charge penalty on insufficient estimated payments and withholding. Income and Gain Potentially Exposed Exempt from the NIIT Retirement account distributions are exempt from the NIIT. Net investment income does not include distributions from qualified retirement plans and arrangements such as pension plans, profit-sharing plans, 401(k) plans, stock bonus plans, tax-favored annuity plans, tax-favored government plans, traditional IRAs, and Roth IRAs. Self-employment income is also exempt from the NIIT. Net investment income does not include any income or deduction items that are taken into account in determining the taxpayer's net selfemployment income for purposes of determining liability for self-employment tax. Exception: The exception to the preceding general rule is for income and deduction items attributable to the business of trading in financial instruments or commodities. These items are taken into account in determining net investment income that is potentially subject to the NIIT whether or not these items are taken into account in determining net self-employment income. The following types of income and gain (net of related deductions) are generally included in the definition of net investment income and thus potentially exposed to the NIIT.

3 Gain from selling assets considered held for investment -- including investment real estate and the taxable portion of gain from selling a personal residence. Capital gain distributions from mutual funds. Gross income from dividends. Gross income from interest (not including tax-free interest such as municipal bond interest). Gross income from royalties. Gross income from annuities. Gross income and gain from passive business activities (meaning business activities in which the taxpayer does not materially participate) and gross income from rents. Gross income from non-passive business activities (other than the business of trading in financial instruments and commodities) is excluded from the definition of net investment income, and so is gain from selling property held in such activities. Gain from selling partnership and S corporation interests held for investment. Gross income and gain from the business of trading in financial instruments or commodities (whether the taxpayer materially participates or not). Calculating Net Investment Income Net investment income is calculated in two steps. Step 1. Add up the gross income and gains from the categories listed above. Step 2. Reduce the total from Step 1 by deductions properly allocable to the income and gains quantified in Step 1. The result is your net investment income. Examples of allocable deductions include investment interest expense, investment advisory and brokerage fees, expenses related to rental and royalty income, and state and local income taxes allocable to income and gains listed in Step 1. Gains from Selling Personal Residences When you sell a principal residence, the gain is federal-income-tax-free to the extent of the allowable exclusion (up to $250,000 for an unmarried taxpayer and up to $500,000 for a married joint-filing couple). Such tax-free principal residence gains are exempt from the NIIT. However to the extent a principal residence gain exceeds the exclusion, the excess is considered investment income that is potentially subject to the NIIT. Gain from selling a vacation property is also potentially subject to the tax. Examples Illustrating How the NIIT Can Affect Individual Taxpayers Example 1: In 2013, you file as unmarried. You have $325,000 of MAGI, which includes $95,000 of net investment income. You owe the 3.8 percent NIIT on all of your net investment income (the lesser of your excess MAGI of $125,000 or your net investment income of $95,000). The NIIT amounts to $3,610 (3.8 percent times $95,000). Example 2: You and your spouse file jointly in You have $425,000 of MAGI which includes $145,000 of net investment income. You owe the 3.8 percent NIIT on $145,000 (the lesser of your excess MAGI of $175,000 or your net investment income of $145,000). The NIIT amounts to $5,510

4 (3.8 percent times $145,000). Example 3: In 2013, you file as an unmarried individual with $199,000 of MAGI. You are exempt from the 3.8 percent NIIT, because your MAGI is below the $200,000 threshold for single taxpayers. Example 4: You and your spouse file jointly in 2013 with $249,000 of MAGI. You are exempt from the 3.8 percent NIIT, because your MAGI is below the $250,000 threshold for joint filers. Examples to Show How the NIIT Can Sneak Up on Some Home Sellers Example 5: You are an unmarried. In 2013, you sell your greatly appreciated principal residence, which you've owned for many years, for a $600,000 gain. Thanks to the principal residence gain exclusion break, your taxable gain for federal income tax purposes is "only" $350,000 ($600,000 gain minus $250,000 exclusion for single taxpayers). The $350,000 gain counts as investment income for purposes of the 3.8 percent NIIT. To keep things simple, assume you have no other investment income and no capital losses. But you do have $135,000 of MAGI from other sources (such as salary, self-employment income and taxable Social Security benefits). Due to the big home sale gain, your net investment income is $350,000 (all from the home sale), and your MAGI is $485,000 ($350,000 from the home sale plus $135,000 from other sources). You owe the NIIT on $285,000 (the lesser of your net investment income of $350,000 or your excess MAGI of $285,000 ($485,000 minus $200,000 threshold for singles). The NIIT amounts to $10,830 (3.8 percent times $285,000). Example 6: You and your spouse file jointly and in 2013, sell a greatly appreciated vacation home you've owned many years. You have a $650,000 gain. That profit is fully taxable, and is also treated as investment income for purposes of the 3.8 percent NIIT. To keep things simple, let's say you have no other investment income or capital losses. But you do have $150,000 of MAGI from other sources. Due to the vacation home profit, your net investment income is $650,000 (from the vacation home sale), and your MAGI is $800,000 ($650,000 from the vacation home plus $150,000 from other sources). You owe the NIIT on $550,000 (the lesser of your net investment income of $650,000 or your excess MAGI of $550,000 ($800,000 minus $250,000 threshold for joint-filing couples). The NIIT amounts to $20,900 (3.8 percent times $550,000). Tax Planning Can Help Minimize or Avoid the NIIT As you can see, the NIIT can bite. However, it's not inevitable. You can minimize or avoid the tax by taking steps to lower your MAGI and/or lower your net investment income. For example, you can lower your MAGI by making larger deductible contributions to tax-favored retirement plans and accounts for the 2013 tax year. You can lower both MAGI and net investment income by selling loser securities (worth less than you paid for them) held in taxable accounts before December 31. Consult with your tax adviser for other tax-saving moves to make between now

5 and year end. The Impact of the Medicare Tax on Partnerships and S Corps A new 3.8 percent Medicare surtax is now imposed on net investment income collected by higher income individuals, estates and trusts. The tax, which the IRS calls the NIIT, is effective for tax years beginning on or after January 1, The NIIT can also have an impact on the income, gains and losses from partnerships and S corporations. This article discusses these issues, based on recent guidance from the IRS. Partnership and S Corporation Income When an individual, estate, or trust holds an ownership interest in a partnership or S corporation and the entity passes through gross income, the income and related deductions are counted in calculating the partner or shareholder's taxable income for regular federal income tax purposes. The passed-through income and related deductions are also counted in calculating the partner or shareholder's net investment income for purposes of the 3.8 percent net investment income tax (NIIT) unless the income is derived in the ordinary course of a non-passive business activity (other than the business of trading in financial instruments or commodities). In other words, passed-through income from a non-passive business activity (other than financial instruments or commodities trading) is exempt from the NIIT. A non-passive activity is one in which the partner or shareholder materially participates. The most straightforward way to meet the material participation standard is by spending more than 500 hours per year in the activity, but there are other ways too. Consult with your tax adviser for details. Example 1: Tom owns stock in State Bank, an S corporation engaged in the banking industry. The bank passes through $50,000 of interest income to Tom, who materially participates in the business. Because the interest income is derived in the ordinary course of State Bank's business and because Tom materially participates in that business, the interest income is considered derived from a non-passive business activity. Therefore, it is not included in calculating Tom's net investment income for NIIT purposes. Variation: If Tom doesn't materially participate in State Bank's business, the $50,000 of passedthrough interest income must be included in calculating his net investment income. Gains Passed Through When an individual, estate, or trust holds an interest in a partnership or S corporation and the entity passes through a gain or loss from selling an asset, it is taken into account in determining the amount of net gain included in the partner or shareholder's net investment income. However, this is not the case if the gain or loss is from an asset held in a non-passive business activity (other than financial instruments or commodities trading).

6 Example 2: Sturdy Corporation is an S corporation engaged in the construction industry. Alicia owns stock in the business. If Sturdy Corp. sells an asset for a gain, the determination of whether Alicia's passed-through share of the gain is included in calculating her net investment income for NIIT purposes depends on: Whether Sturdy Corp. held the asset in its business and If it did hold the asset in its business, whether Alicia materially participated in that business. If Sturdy Corp. held the asset in its business and Alicia materially participates in the business, the passed-through gain from the asset sale is not included in calculating her net investment income. If both of those two conditions are not met, however, the passed-through gain from the asset sale must be included in Alicia's net investment income. Gains from Selling Partnership and S Corp Interests General Rule: According to the proposed regulations, an interest in a partnership or S corporation is generally considered to be held in passive business activity. In such case, the gain or loss from selling an interest is included in calculating the selling partner or shareholder's amount of net gain that is included in net investment income for NIIT purposes. Exception for Interests Held in Non-Passive Business: Subject to a complicated special rule explained immediately below, a gain or loss from selling a partnership or S corporation interest that is considered held in a non-passive business activity is not taken into account in determining the selling partner or shareholder's net investment income. One example of a partnership and S corporation interest that would be considered held in a non-passive business activity is a service provider's interest in a personal service partnership or S corporation -- such as a medical or dental practice. Special Gain/Loss Adjustment Rule When all or part of the partnership or S corporation interest in question is considered held by the selling partner or shareholder in a non-passive business, a special gain/loss adjustment rule is used to implement the aforementioned exception. The intent of the special rule is to exclude from the selling partner or shareholder's net investment income the portion of the gain or loss that is deemed to come from assets that are held in a non-passive business. Eligibility: The special gain/loss adjustment rule is only available when the following two conditions are satisfied with respect to the partnership or S corporation interest being sold. 1. The partnership or S corporation is engaged in one or more businesses other than the business of trading in financial instruments or commodities. 2. The selling partner or shareholder materially participates in at least one of those businesses. Therefore, the special gain/loss adjustment rule is inapplicable when: There is no business at the entity level; The entity's business or businesses are passive activities with respect to the selling partner or shareholder; or The entity's only activity is trading in financial instruments or commodities.

7 In these situations, the net gain or loss for NIIT purposes from selling the partnership or S corporation interest is calculated in the usual fashion by subtracting the tax basis of the interest from the net sale proceeds -- without any adjustment in the resulting net gain or loss. Example 3: ABC Landscaping is a general partnership owned by two individuals. Andy owns a 60 percent interest, and Betty owns the remaining 40 percent interest. ABC owns several assets, all of which are used in the landscaping business. Andy materially participates in ABC's business, but Betty does not. In 2013, Andy sells his ABC interest for a net sale price of $600,000, and Betty sells her ABC interest for a net sale price of $400,000. At the time of sale, Andy's basis in his interest is $120,000, and Betty's basis in her interest is $80,000. For regular federal income tax purposes, Andy has a $480,000 gain from the sale of his interest ($600,000 minus $120,000), and Betty has a $320,000 gain ($400,000 minus $80,000). Under the eligibility provision explained above, Andy is eligible for the special gain/loss adjustment rule. He should use it to calculate the gain from the sale of his ABC interest for NIIT purposes. If he does, the amount of gain he will have to include in his net investment income will be less than his regular tax gain of $480,000. The reduced gain will result in a lower NIIT bill, which is good news for Andy. Betty is ineligible for the special rule because she didn't materially participate in the landscaping business. Therefore, she must include her entire $320,000 gain from selling her passive interest in ABC when calculating her net investment income for NIIT purposes. Mechanics: The special gain/loss adjustment rule is implemented by using an asset-by-asset hypothetical sale gain/loss calculation. The selling partner or shareholder calculates the gains and losses that would result from the hypothetical sale of all the underlying assets of the entity for fair market value. If the hypothetical sale results in a required adjustment, the gain/loss calculated under the regular federal income tax rules is adjusted to arrive at the net gain/loss amount that must be taken into account in arriving at net investment income for NIIT purposes. (Proposed Treasury Regulation ) Plan Ahead You may be able to reduce or avoid the NIIT by taking steps to lower your MAGI and/or lower your net investment income. For example, you may be able to spend enough extra hours in a partnership or S corporation activity to make the income non-passive and therefore exempt from the NIIT. Also, partnerships and S corporations can sell assets that will produce losses to offset gains and thereby reduce their owners' exposure to the tax. In addition, you can lower your MAGI by making larger deductible contributions to tax-favored retirement plans and accounts for the 2013 tax year. Consult with your tax adviser about your situation. Mapping Out Taxes for Personal Service Corporations It's bad enough that every corporation must pay income tax at rates reaching up to 35 percent (a portion of income may actually be taxed at a 39 percent rate -- see chart at the bottom of this article). But the tax burden is even more onerous for corporations labeled as "personal service corporations." In that case, the tax rate is a flat 35 percent. Thus, personal service corporations don't benefit from the graduated rate structure that other

8 corporations do. This anomaly in the tax law can cost some companies thousands of extra tax dollars. Personal services include activities performed in the fields of accounting, actuarial science, architecture, consulting, engineering, health (including veterinary services), law, and the performing arts. --The IRS Naturally, the determination of this tax status is often contested in the courts. In one case, the Tax Court said a corporation qualified as a personal service corporation even though its employees weren't licensed professionals in the field. Background: The tax law definition isn't completely clear-cut, but a corporation is generally treated as a personal service corporation if it meets a "function" and an "ownership" test. 1. Function test: Substantially all of the activities involve the performance of services in a field of law, accounting, health, engineering, architecture, actuarial sciences, performing arts or consulting. For this purpose, "substantially all" means that 95 percent or more of time spent by employees is devoted to these services. 2. Ownership test: Substantially all of the stock is held, either directly or indirectly, by employees performing these services or retired employees who provided these services. Ownership of 95 percent or more of the stock is considered to be "substantially all" ownership. Facts of the case: In the case, Kraatz & Craig Surveying Inc. was engaged solely in land surveying. It did not employ any licensed engineers nor was it associated with any firm employing licensed engineers. The Tennessee firm did not dispute that it met the ownership test for being a personal service corporation. However, it argued it did not meet the function test because it was not engaged in any of the specified services. The IRS contended that the land surveying constituted performance of engineering. It based its position on existing regulations that treat land surveying and mapping as engineering services (Regulation T(e)(4)(i)). The surveying firm countered by saying that the regulation was invalid. It argued that the firm's services would qualify as "engineering" under state law only if they were performed by licensed engineers. Result: The Tax Court sided with the IRS. First, it upheld the regulation as being valid. In addition, the Court ruled that the determination of whether a corporation is a personal service corporation should be based on all the relevant facts and is not controlled by state law. Accordingly, the surveying firm was responsible for a tax deficiency of $9,762. (Kraatz & Craig

9 Surveying, Inc., 134 TC No. 8). Your CPA firm can analyze whether a business satisfies the definition of a personal service corporation and the most tax-effective way an entity should be structured. Corporate Tax Rates for Non-Personal Services Corporate taxable income over Not over Tax Rate $ 0 $ 50,000 15% 50,000 75,000 25% 75, ,000 34% 100, ,000 39% 335,000 10,000,000 34% 10,000,000 15,000,000 35% 15,000,000 18,333,333 38% 18,333,333-35% The impact for personal service corporations is especially acute at lower income levels. For instance, a personal service corporation with $100,000 of annual income pays $35,000 in tax in contrast to $22,250 for a regular C corporation -- a difference of $12,750. Taxes on Personal Injury Awards and Settlements Award or Settlement: Who Owes Federal Tax? Hopefully, you will never need to know how payments for personal injuries are taxed. But here are the rules, just in case you or a loved one does need to understand the rules. Payments for Physical Injury or Sickness Are Federal-Income-Tax-Free Payments you receive as compensation for physical injury or physical sickness are federalincome-tax-free. It does not matter if the compensation is from a court-ordered award or an outof-court settlement, and it makes no difference if it is paid in a lump sum or installments. Compensation for emotional distress that arises from physical injury or sickness is also tax-free, because the distress is considered part and parcel of the physical injury or sickness. Amounts received for medical expenses are tax-free too. However, if you claim a medical expense deduction for

10 From the IRS The IRS provides its auditors with a guide explaining the taxability of different types of awards and settlements. Here are some excerpts. Wrongful Death: "Claims for wrongful death usually encompass compensatory damages for physical and mental injury, as well as punitive damages for reckless, malicious, or reprehensible conduct. As a result, both claims may generate settlement amounts. Any amounts determined to be compensatory for the personal injuries are excludable from gross income... The amounts determined to be non-compensatory, that is, punitive payments, are not excludable." Libel and Defamation of Character: "Because damage to reputation, be it personal or business, is a nonphysical injury, only out of pocket costs to treat emotional distress can be excluded. Any other compensatory and punitive damages arising from these cases are taxable." Other Non-Physical Personal Injury: Lawsuits companies for negligence, fraud, breach of contract, etc., can include a variety of claims, and therefore can produce a variety of types of awards/settlements. Under current tax law, "only out-of-pocket amounts for medical costs incurred to treat any emotional distress claims would be excludable from income. All amounts determined to represent punitive damages are taxable." Back Pay Settlement after Termination: Let's say an employee is illegally fired under a worker's right or civil rights law. As part of a settlement, he or she receives back pay relating to a period when no services for the employer were performed because of the termination. The IRS states the back pay is considered "wages subject to employment taxes in the year paid, and subject to the tax rates and FICA and FUTA wage bases in effect in

11 costs that are later reimbursed by an award or settlement, you must "recapture" any amount that is specifically allocated to medical cost reimbursements up to the amount you've previously deducted on your tax returns. When there is no specific allocation to previouslydeducted medical expenses, the award or settlement is automatically considered to be a reimbursement for such expenses up to the amount of those expenses. (IRS Revenue Ruling ) If any part of your award or settlement is deemed to be interest for the period between the physical injury or sickness and the time you get paid, that part is taxable. (This "origin of the claim" doctrine was decided in the key court case of Rosemary Kovacs, 100 TC 124, 1993, which was affirmed by 6th Circuit Court of Appeals in 1994) Oddly enough, amounts paid for lost wages are federal-income-tax-free, even though the wages would have been taxable if you had received them. Example: Let's say you were seriously injured in a 2011 auto accident. You racked up $65,000 in medical expenses and $80,000 in lost wages. On your 2011 and 2012 returns, you claimed medical expense deductions totaling $40,000 (you couldn't deduct the full $65,000 because of tax-law limitations on medical write-offs). You eventually receive a $650,000 out-of-court settlement that covers medical expenses, lost wages, pain and suffering, and $50,000 for interest. Only $90,000 is taxable ($40,000 for the medical expenses that were previously deducted and then reimbursed and the $50,000 for interest). The remaining $560,000 ($650,000 minus $40,000 minus $50,000) is free from federal income tax. Other Payments Are Generally Taxable Payments for legal (as opposed to physical) injuries from things like harassment, discrimination, wrongful termination, libel, and invasion of privacy are taxable. The same is true for payments for emotional distress that is not caused by physical injury or sickness. Related payments for interest are also taxable. As a general rule, payments for punitive damages (amounts paid for the specific purpose of punishing the wrongdoer) are taxable even if they are paid as compensation for physical injury or sickness. There is one exception to this general rule. Federal-income-tax-free treatment applies to punitive damages paid in civil wrongful death actions when applicable state law, in effect on September 13, 1995, only allows punitive damages in such cases. Interest payments related to punitive damages (whether taxable or tax-free) are taxable. What about Attorney Fees? the year paid" -- Source: IRS Market Segment Specialization Program Publication Lawsuit Awards and Settlements You cannot deduct attorney fees incurred to collect a tax-free award or settlement for physical injury or sickness. In other words, no deductions are allowed for fees to collect tax-free compensation. After that, the rules change and are not so favorable. Let's say part of your award or settlement is tax-free (for physical injury or sickness), and part is taxable (for interest or punitive damages). As a general rule, you must report the full amount of the taxable portion of the award or settlement as income on your return, without any reduction for the related attorney fees. Then, you can treat

12 the fees related to the taxable portion as a miscellaneous itemized deduction item on Schedule A of your Form Calculate the deduction by multiplying the total fees by a fraction. The numerator is the taxable portion of your award or settlement, and the denominator is the total amount of the award or settlement. Unfortunately, there are harsh limitations on miscellaneous itemized deductions. You can only write them off to the extent they exceed 2 percent of your adjusted gross income. In addition, they are completely disallowed for alternative minimum tax purposes. Therefore, your actual write-off for legal fees may be reduced to little or nothing. In this unfortunate scenario, you could potentially wind up with only a small fraction of your award or settlement after paying your attorney and the IRS. Special Rule for Attorney Fees in Discrimination Cases There is one big exception to the preceding unfavorable general rule for attorney fees. Fees incurred in certain unlawful discrimination cases can be deducted in full on page 1 of your Form 1040 without any limitations. That way, you are not taxed on this money because you can deduct the amount. For purposes of this beneficial exception, unlawful discrimination is defined as violating any one of a whole list of laws that mostly have to do with civil rights, labor and employment rights, housing rights, disability rights, and whistleblower rights. If your case does not involve violating one of these laws, your attorney's fees fall under the unfavorable general rule (miscellaneous itemized deduction treatment applies and your actual write-off may be little or nothing). Remember: The issue of deducting attorney fees only arises in the context of an award or settlement that is at least partially taxable. Fees related to tax-free compensation for physical injury or sickness are always non-deductible.