Getting the Jump on Year-End Tax Planning Ideas for Individuals

Transcription

2 3.8% Medicare Surtax As applied to individuals, tax is 3.8% of lesser of: Net investment income (NII) for the tax year, or The excess of MAGI for the tax year over the threshold amount.

3 Copyright 201Copyright 2012 All-Star Tax Series, LLC 2 All-Star Tax Series, LLC Individual MAGI Threshold Amount For taxpayer MFJ or a surviving spouse: $250,000 For taxpayer MFS: $125,000 Any other case (individual): $200,000 Bottom Line: if MAGI under these amounts, no 3.8% tax!

4 Copyright 2012 All-Star Tax Series, LLC Net Investment Income Gross investment income over allocable investment expenses Investment income for purposes of the 3.8% tax includes the sum of: Interest Dividends Annuities Royalties Rents (unless active) Passive activity income (like a partnership interest treated as a passive activity) Capital gain Income from a trade or business of trading in financial instruments or commodities (hedge funds) Oil and gas production payments, royalties, or other income arrangements if the investment is not a working interest

5 Copyright 2012 ACopyright 2012 All-Star Tax Series, LLC ll-star Tax Series, LLC Income Not Treated as Investment Income Active trade or business income Any investment income (interest, dividends, etc.) to the extent derived in an active trade or business Any distribution from a qualified retirement plan, qualified annuity, or IRA Any income taken into account for purposes of determining the taxpayer s SE income A working interest in an oil and gas property that a taxpayer holds through an entity that does not limit the taxpayer s liability, or one held directly

6 Wandry v. Comer, TC Memo In 2001, taxpayers began to gift interests in Norseman Capital, LLC to their children. Number of member units gifted equal to the desired value of gifts on any given date, unknown until valued later. All gifts given as specific dollar amounts, rather than specific numbers of member units (see language on the next slide )

7 Wandry v. Comer, TC Memo Although the number of member units gifted is fixed on the date of the gift, that number is based on the fair market value of the gifted member units, which cannot be known on the date of the gift but must be determined after such date based on all relevant information as of that date. If, after the number of gifted member units is determined based on such valuation, the IRS challenges such valuation and a final determination of a different value is made by the IRS or a court of law, the number of gifted member units shall be adjusted accordingly so that the value of the number of member units gifted to each person equals the amount set forth above, in the same manner as a federal estate tax formula marital deduction amount would be adjusted for a valuation redetermination by the IRS and/or a court of law.

8 Wandry v. Comer, TC Memo Donors transferred an ascertainable dollar value of stock even though the units themselves had an unknown value. Bottom line: tax practitioners may now rely on formula clauses, not only as another tool for estate planning with a charitable component, but also in situations where no charitable giving is contemplated.

9 Copyright 2012 All-Copyright 2012 All-Star Tax Series, LLC Star Tax Series, LLC Eugene A. Fisher et al. v. U.S. (Ct Cl 8/6/2008) 102 AFTR 2d The Court of Federal Claims applied the open transaction doctrine with the result that a policyholder had no gain to report when it chose a cash option in connection with a demutualization of an insurance company. Shares awarded to the policyholder were immediately sold by the company, and the proceeds were then paid to the policyholder in cash. IRS said that the policyholder was taxable on the full amount of the gain without being able to allocate any of his basis in the contract to offset the sales proceeds. The Court allowed the policyholder to use his basis in the contract (which greatly exceeded the amount of the sales proceeds) to fully offset the proceeds, and thus to report no gain.

10 Copyright 2012 All-StaCopyright 2012 All-Star Tax Series, LLC r Tax Series, LLC Dorrance v. U.S., (DC AZ 7/9/2012) 110 AFTR 2d The court stated that the open transaction doctrine did not apply to the facts in this case, as the basis in the insurance contracts could be reasonably allocated between the stock received in the demutualization and the insurance policies maintained after the demutualization transaction. The trial will focus on determining the most equitable method to use to allocate the basis between the post-demutualization insurance contracts and stock.

11 Qualified Principal Residence Indebtedness Proceeds of refinanced debt used for other purposes (for example, to pay off credit card debt) do not qualify for the exclusion. If a taxpayer qualifies, he/she claims the special exclusion by filling out Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attaches it to his/her federal income tax return for the tax year in which the qualified debt was forgiven. Debt forgiven on second homes, rental property, business property, credit cards or car loans does not qualify for the tax relief provision. In some cases, however, other tax relief provisions, such as insolvency, may be applicable.

12 Qualified Principal Residence Indebtedness If a taxpayer s debt is reduced or eliminated, he/she normally will receive a year-end statement, Form 1099-C, Cancellation of Debt, from his/her lender. Examine the Form 1099-C carefully. Notify the lender immediately if any of the information shown is incorrect. Taxpayer should pay particular attention to the amount of debt forgiven in Box 2 as well as the value listed for taxpayer s home in Box (a)(1)(E) expires at the end of 2012.

13 Copyright 2012 All-Star Copyright 2012 All-Star Tax Series, LLC Tax Series, LLC Qualified Principal Residence Indebtedness A taxpayer can exclude canceled debt from income if it is qualified principal residence indebtedness. Qualified principal residence indebtedness is any mortgage a taxpayer took out to buy, build, or substantially improve his or her main home. It also must be secured by taxpayer s main home. A taxpayer s main home is the home where he or she ordinarily lives most of the time. A taxpayer can have only one main home at any one time. Qualified principal residence indebtedness also includes any debt secured by the main home that taxpayer used to refinance a mortgage he or she took out to buy, build, or substantially improve his or her main home, but only up to the amount of the old mortgage principal just before the refinancing.

14 Copyright 2012 All-Star Copyright 2012 All-Star Tax Series, LLC Tax Series, LLC Qualified Principal Residence Indebtedness This exclusion does not apply to a cancellation of debt in a Title 11 bankruptcy case. If qualified principal residence indebtedness is canceled in a Title 11 bankruptcy case, the taxpayer must apply the bankruptcy exclusion rather than the exclusion for qualified principal residence indebtedness. If the taxpayer was insolvent immediately before the cancellation, he or she can elect to apply the insolvency exclusion instead of applying the qualified principal residence indebtedness exclusion. The maximum amount a taxpayer can treat as qualified principal residence indebtedness is $2 million ($1 million if married filing separately).

15 Short Sales and Foreclosures Short sale: selling home for less than the mortgage balance/lender forgives the unpaid balance. Foreclosure: legal procedure whereby property used as security for a debt is sold to satisfy the debt in the event of default in payment of the mortgage note or default of other terms in the mortgage document. Short sales are taxed under the same tax rules as foreclosures.

16 Copyright 2012 All-StCopyright 2012 All-Star Tax Series, LLC ar Tax Series, LLC Short Sales and Foreclosures When a nonrecourse mortgage is foreclosed, the property is treated as being sold for the balance of the mortgage. Gain from a foreclosure of a principal residence may be eligible for the Section 121 exclusion.

17 Short Sales and Foreclosures: Example of Foreclosure of a Nonrecourse Debt Nonrecourse debt $1,000,000 Tax basis $600,000 Gain $400,000* *Potentially subject to the Section 121 exclusion

18 Copyright 2012 All-SCopyright 2012 All-Star Tax Series, LLC tar Tax Series, LLC Short Sales and Foreclosures: Example of Foreclosure of a Recourse Debt Debt satisfied only up to FMV of property Sale up to that amount If lender forgives the balance of the mortgage, there is CODI, which is ordinary income: Recourse debt $1,000,000 FMV $900,000 CODI $100,000* *If CODI was for qualified principal residence debt, it will be excluded from taxable income.

19 Short Sales and Foreclosures: Example of Foreclosure of a Recourse Debt FMV $900,000 Tax basis $600,000 Gain $300,000* *May be subject to Section 121 exclusion

20 Recharacterizing a Roth IRA Net income = Contribution x Adjusted closing balance adjusted opening balance Adjusted opening Balance Net Income = the earnings or loss on the amount being recharacterized. Contribution = the conversion or contribution amount being recharacterized. Adjusted Opening Balance = FMV of the IRA at the beginning of the computation period plus the amount of any contributions or transfers (including the contribution that is being recharacterized and any other recharacterization) made to the IRA during the computation period. Adjusted Closing Balance = FMV of the IRA at the end of the computation period plus the amount of any distributions, transfers or recharacterization made from the IRA during the computation period.

21 Recharacterizing a Roth IRA The computation period begins immediately prior to when the contribution being recharacterized is made to the IRA and ends immediately prior to the recharacterizing of the contribution. If the IRA is not valued on a daily basis, the most recent available FMV preceding the contribution may be used as the beginning of the period, and the most recent available FMV preceding the recharacterization is the ending FMV. A calculation of earnings or loss is required only if a partial recharacterization is being done. If the full IRA balance is being recharacterized, no calculation is required.

22 Tax Reporting Forms on Recharacterization IRA custodian will report taxpayer s IRA contributions (to taxpayer and the IRS) on IRS Form This contribution will be reported even if it is later recharacterized. Thus, if recharacterize contribution, taxpayer will receive two Form 5498s, one for the initial contribution and a second for the amount that is credited to the other IRA as a recharacterization. Will also receive one Form 1099-R for the IRA that first received the contribution. Custodian will use a special code in box 7 of the Form R to indicate that the transaction is a recharacterization and therefore not taxable.