Cohen Smith & Company, P.A. NEWSLETTER. CERTIFIED PUBLIC ACCOUNTANTS Business and Personal Advisors 133 EAST INDIANA AVENUE DELAND, FLORIDA

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1 Cohen Smith & Company, P.A. NEWSLETTER CERTIFIED PUBLIC ACCOUNTANTS Business and Personal Advisors 133 EAST INDIANA AVENUE DELAND, FLORIDA Phone: (386) Fax: (386) Interested in knowing more about our firm? Please take a minute to browse our website at June 2012 In This Issue Tax Planning for the Unearned Income Medicare Contribution Tax Tax-Free Exchanges of Life Insurance Policies Florida Corporate Income Tax Tax Calendar Tax Planning for the Unearned Income Medicare Contribution Tax (UIMCT) In last month s newsletter we discussed the new Unearned Income Medicare Contribution Tax (UIMCT). The UIMCT, combined with the scheduled increase in the top marginal tax rate, could significantly increase the marginal tax rate that higher-income taxpayers pay on investment income. The net effect of the scheduled increase in the top marginal tax rate to 39.6% and the UIMCT is to increase the top rate paid on investment income from 35% to 43.4% (39.6% + 3.8%).

2 In addition, the preferential 15% rate on qualified dividends is scheduled to expire in This would increase the highest top marginal rate on qualified dividends from 15% to 43.4%. The UIMCT applies only to taxpayers with both MAGI above the threshold amount and net investment income (or both). Income Recognition and Deferral Planning - UIMCT In order to minimize the UIMCT tax, you need to be aware of items of income that are excluded from income and therefore, reduce MAGI and net investment income. This provides higherincome taxpayers potentially subject to the UIMCT additional incentive to structure transactions that result in either tax-exempt or tax-deferred income. Higher-income taxpayers can minimize the UIMCT by including nondividend paying growth stocks, which do not increase MAGI or create investment income until sold, in their investment portfolio. Taxdeferred annuities and related investments will also minimize liability for the UIMCT, and may become more popular. Because tax-exempt income is not included in either MAGI or investment income, higherincome taxpayers will have increased incentive to invest in state and local obligations exempt from tax. The scheduled increase in the highest marginal tax rate increases this incentive. Example: Frank, an unmarried taxpayer in the highest marginal tax bracket, is deciding whether to invest in corporate bonds earning 8% or tax-exempt bonds of equal risk earning 5%. Under current law, Frank should invest in the corporate bonds because the 5.2% after-tax rate of return (8% x (1-35%MTR)) on the taxable corporate bonds exceeds the 5% aftertax rate of return on the tax-exempt bonds. Beginning in 2013, however, interest on taxable bonds will be subject to 3.8% UIMCT. In addition, the top marginal rate will increase to 39.6%. These changes will decrease the after-tax rate of return on the taxable bonds to 4.528% (8% x (1-43.4% MTR)), significantly lower than the 5% after-tax rate of return on the tax-exempt bonds. Capital Gain Planning - UIMCT Investment income includes net gain (to the extent taken into account in computing taxable income) from the disposition of property. Tax planning strategies that reduce or defer capital gain income will also reduce or defer net investment income for purposes of the UIMCT. Using the installment method of accounting to report gain on the sale of property sold on an installment basis, for example, will minimize the impact of the UIMCT because it avoids a large increase in both MAGI and investment income in the year of sale. Taxpayers selling property on an installment basis in 2012, on the other hand, should consider possibly electing out of the installment method and recognizing the entire amount of the gain before the 3.8% UIMCT goes into effect. Because gain on the disposition of property is included in investment income only to the extent it is taken into account in computing taxable income, taxpayers should analyze their portfolios at the end of the year to determine whether they can reduce their MAGI and investment income. For example, selling stock that has decreased in value and using the loss to offset capital gain that would otherwise be included in income will reduce both MAGI and investment income. Such a strategy, of course, must make sense from an investment standpoint. In addition, taxpayers need to be mindful of the wash sales rules, which provide that loss on the sale of stock cannot be recognized if substantially identical securities are purchased within 30 days of the sale.

3 Retirement Income Planning - UIMCT Because distributions from qualified retirement plans are not included in net investment income, the UIMCT provides taxpayers with additional incentive to maximize retirement plan contributions. Although retirement plan distributions are not included in net investment income, distributions that are included in income (such as those from a traditional IRA or 401(k)) increase MAGI. This increase in MAGI may increase the amount of other investment income subject to the UIMCT. Retirement plan distributions that are not included in income (such as those from a Roth IRA or Roth 401(k)), on the other hand, do not increase MAGI. This provides higher-income taxpayers with incentive to contribute to Roth type retirement plans, rather than traditional plans. On the other hand, contributions to traditional retirement plans reduce MAGI in the year of contribution, while contributing to Roth plans do not. Taxpayers with MAGI near the threshold level may be able to avoid or reduce current year s UIMCT by contributing to a traditional plan and reducing MAGI below the threshold. Taxpayers may want to consider a 2012 Roth conversion in appropriate situations. Although the conversion amount will be included in income, the income will be recognized in 2012, before the increase in the top marginal tax rate and the effective date of the UIMCT. Once the retirement funds are in a Roth account, distributions are not included in either MAGI or investment income. UIMCT. The UIMCT gives taxpayers with passive activities, including passive rental activities, an additional factor to consider in passive activity planning. Estate Planning - UIMCT The UIMCT provides higher-income taxpayers with another incentive to consider the use of family limited partnerships and related estate planning techniques. Investment income transferred from parents with significant MAGI and investment income to children with MAGI below the applicable threshold amounts through the use of family limited partnerships will not be subject to UIMCT on what otherwise would be the parent s investment income. Although investment income transferred to children through a family limited partnership may be taxed at their parent s rate under the kiddie tax rules, the children will be subject to the UIMCT only if their income (including income from a family limited partnership) exceeds the applicable threshold. Children subject to the kiddie tax are taxed at their parent s rate for purposes of the regular tax imposed by Section 1. Because the UIMCT is imposed under Section 1411, rather than Section 1, children will not be subject to the UIMCT merely because their parents are. Taxpayers considering using family limited partnerships or similar entities should seek the advise of an estate planning specialist to make sure the entity is properly structured and operated in a manner that satisfies appropriate standards. Passive Activity Loss Planning - UIMCT Taxpayers should consider the UIMCT in planning for investments in passive activities (limited partnerships, for example). Passive income is considered investment income for purposes of the

4 Conclusion The new 0.9% Medicare tax on earned income in excess of $250,000 (married filing jointly) and 3.8% tax on net investment income will undoubtedly increase tax burden of higher-income taxpayers beginning in Taxpayers should begin planning now in order to minimize the impact of these taxes in 2013 and beyond. Tax-Free Exchanges of Life Insurance Policies A periodic life insurance review is essential to ensure life changes have not altered the original intent for purchasing a policy, cover new or additional requirements, address concerns about the financial soundness of the insurer, and deal with various other issues. However, replacing a life insurance policy can create adverse federal income tax consequences. Specifically, a taxable gain can result if the policy is surrendered when its cash surrender value is greater than the tax basis in the policy. The policy s tax basis is typically the total premiums paid less any tax-free distributions, e.g., dividends or the surrender of part of the policy. With careful planning, however, a policy exchange that qualifies under Internal Revenue Code Section 1035, known as a 1035 exchange, can be used to replace one life insurance policy with another. Any gain or loss generated upon such an exchange is not recognized currently for income tax purposes. As previously noted, individuals may consider replacing or exchanging life insurance policies for a number of reasons. One of the more important reasons is the financial strength and soundness of their insurance company. Individuals whose policies are held by companies with questionable stability often want to replace them with those of companies deemed more financially sound, usually based on the ratings of companies that rate insurance company financial strength. Replacement with policies from a more financially viable company may avoid a future loss of benefits or value in the event the initial insurer becomes insolvent. Some policy holders benefit from replacing a policy with one that provides an increased rate of return. The fees charged by insurers may also be a factor since they affect the policy s rate of return. Individuals who own multiple policies may want to combine those into fewer, larger policies to ease the administrative burden of maintaining them. Finally, an individual s financial needs may change, making one type of contract or policy more desirable than another. Individuals contemplating a 1035 exchange of policies should be aware of certain disadvantages of making an exchange. With respect to a life insurance policy, an exchange for another policy may start a new incontestability period (the period of time the insurer has specific rights to deny a claim). There may also be disadvantageous provisions within the new policy. Finally, additional fees and other costs may be associated with an exchange. Note: The 1035 exchange provision applies to life insurance, annuity, and endowment contracts. Qualifying exchanges include not only policies of the same type, but also, in some cases, policies of different types. Florida Corporate Income Tax The Department of Revenue has issued a Tax Information Publication that summarizes the 2012 legislative changes affecting the Florida corporate income tax.

5 One of the most important parts of the legislation amends Florida law to adopt the Internal Revenue Code retroactively to January 1, 2012 so that Florida will follow the computation of federal taxable income. In addition, effective for tax years beginning on or after January 1, 2013, the Florida Corporate income tax exemption will be increased from $25,000 to $50,000. This will eliminate the tax on corporations with $50,000 or less in Florida income; however, all corporations are still required to file Florida corporate income tax returns. JUNE 2012 June 11 Employees who work for tips. If you received $20 or more in tips during May, report them to your employer. You can use Form June 15 Individuals. Make a payment of your 2012 estimated tax if you are not paying your income tax for the year through withholding (or will not pay in enough tax that way). Use Form 1040-ES. This is the second installment date for estimated tax in For more information, see Publication 505. Employers. For Social Security, Medicare, withheld income tax, and nonpayroll withholding, deposit the tax for payments in May if the monthly rule applies. Corporations. Deposit the second installment of estimated income tax for A worksheet, Form 1120-W, is available to help you estimate your tax for the year. JULY 2012 July 10 Employees who work for tips. If you received $20 or more in tips during June, report them to your employer. You can use Form July 16 Employers. For Social Security, Medicare, withheld income tax, and nonpayroll withholding, deposit the tax for payments in June if the monthly rule applies. July 31 Social Security, Medicare, and withheld income tax. File Form 941 for the second quarter of Deposit any undeposited tax. (If your tax liability is less than $2,500, you can pay it in full with a timely filed return.) If you deposited the tax for the quarter in full and on time, you have until August 10 to file the return. Federal unemployment tax. Deposit the tax owed through June if more than $500. All employers. If you maintain an employee benefit plan, such as a pension, profitsharing, or stock bonus plan, file Form 5500 or 5500-EZ for calendar year If you use a fiscal year as your plan year, file the form by the last day of the seventh month after the plan year ends. Other helpful on-line services &