Back in the 1980’s high income individuals and corporations were perceived to be skewing their income through converting capital gains to ordinary income, buying assets and taking advantage of depreciation and tax credits and seemed to owe little or no taxes. To require them to pay “something” Congress came up with the alternative minimum tax. It is a separate tax calculation. Very basically, all deductions, exemptions are disallowed the the taxpayer gets a single exemption of $70,950 for married couples filing jointly The AMT rate is 26-28% depending on income. 26% on the first $175,000 of income and 28% on anything about that (again married filling jointly). The capital gain rate is 25%. Depreciation is calculated at slower rates, tax exempt private activity bonds interest (like Airport and sports arena bonds) are added back into the calculation. Depreciation deductions are limited. Incentive stock option income is added in. Certain farm tax shelter losses are added back in. In a corporate context, long term contracts are re-calculated, key man life insurance proceeds are added back in. Because of the way it works, planning to avoid the AMT is well nearly impossible. For example, a person pays his state estimated income taxes and his real estate taxes in a year when due. Such expenditures may trigger AMT. Or employee business expenses may likewise trigger the AMT. The funny thing is that once you are subject to the AMT, the numbers always turn out the same, no matter what the deductions are. The reason that AMT expiring tax provision is a huge deal is that the trigger number for the AMT will go down from $70,950 to $45,000 in 2011 (for married couples). This means that more taxpayers will be subject to AMT.
Monthly Archives: October 2010
Let’s explore some of these suggestions
Suppose you start a new business in the last two months of the year and it is a C corporation. The good news is that if you sell the stock in that business down the road you will not owe capital gains taxes. In the meantime, however, profits of the business will pay corporate level taxes and when you pay yourself dividends, they will be taxed at very high rates. If you “zero out” the income of the business by paying yourself a huge bonus, the IRS can come in and call that bonus a disguised dividend and hit you and the corporation with taxes and penalties (if that bonus is deemed to be excessive compensation (which we’ll examine down the road). So, while you are being offered a potentially huge benefit by excluding capital gains, you will be paying for it in the meantime. Had you instead chose an S Corporation or an LLC you would avoid the corporate level tax and would avoid the excessive compensation issues since those are flow through entities.
So, you have to run the numbers and see whether its worthwhile to do this. Also, if you have an LLC which might be sold in five years, this might be a time to convert it to a C Corporation, but you’d need to review the issues involving excessive compensation before you make that choice. We’ll next discuss the concept of alternative minimum taxes.
PLANNING CONSIDERATIONS FOR THE END OF 2010
1. CAVEAT: All planning recommendations are based upon the Tax Code as it exists today. Obviously, with a lame duck session predicted, it is altogether likely that there may very well be comprehensive tax reform coming out of Congress in the last month of the year, so please check with your tax advisor before taking any steps. Although it was before my time, in 1976 in a lame duck session, Congress passed one of the most comprehensive tax changes in history. So, it is not unprecedented. This is also not a covered opinion and cannot be used to avoid penalties for taxes.
2. DIVIDENDS AND CAPITAL GAINS: Unless a tax bill comes out of Congress dividend rates will increase from 15% to marginal rates and capital gains to 20%. That means that income sensitive stocks like utilities and “blue chips” will likely take a hit in value after the first of the year (or leading up to the end of the year). So, review these stock holdings with your tax advisor. Remember the 30 day rule, if you sell a stock to recognize a loss, you can’t buy it back for 30 days or the loss will be voided.
3. ALTERNATIVE MINIMUM TAXES: Unless Congress Acts, alternative minimum taxes will go up in 2011. That means that deductible items like state income taxes and real estate taxes will not be as useful in 2011. So, depending on your situation (and it really is a case by case basis), you might be better off making tax payments in 2010 and using the deduction in 2010.
4. PURCHASES: There will be some bonus depreciation and Section 179 added tax credits for business purchases in 2010.
5. STARTING A NEW BUSINESS: For those who start a new business in 2010 and sell it by 2012, there will be an unlimited exclusion for taxes. This only applies to Corporations. I suspect that the IRS will not allow LLC ‘s to convert to C corporations to get this benefit. But it might be something to watch.
6. GIFTS TO FAMILY MEMBERS: If Congress doesn’t change the law, next year the Estate and Gift tax exclusion will be $1 Million. This year the gift tax exclusion is $1 Million. Above $1 Million, gifts are taxable. But the rate for taxable gifts in 2010 is 35% in 2011 they go up to 45% at a minimum. So, if you have a person who is sick and might not make it too far into 2011, it might save money to incur a gift tax in 2010, than an estate tax in 2011 where rates are 55%. Again this should be reviewed to be done no earlier really than December 30 or 31.
7. DYING: As the law currently is written, if you’re worth more than $1 Million, it’s a good year to die. I understand that in Haiti, there is a voodoo cocktail administered by a voodoo priest made up of certain specific drugs. The creation of real life zombies began in the practice of Haiti and is linked to the practice of voodoo. Although magic is typically credited with the creation of a zombie, some very real drugs are used to cause the half-living state of the creatures.
The problem is that if you are left in the coffin, too long, you will suffer brain damage or death. Or the dose may not be perfect and you will die. So, this is not recommended. But would make for one heck of an estate tax case. When is a dead person, undead?
8. 2011 RECORDKEEPING: If you rent out real property and spend over $600 with any service provider, you will need to send them a 1099-MISC starting in 2011. So be sure and ask for their EIN or social security number so that you don’t have to try and get it in January, 2012. Always best to ask before you pay them than after you pay them.
9. CHRISTMAS SEASONAL HIRES: If you hire an employee for 60 days and 40 hours per week, you get an exemption for wages paid through 12/31/10, there is an exemption from Employer’s share of OASDI (6.2%). Employee must sign new W-11. Can’t take the Work Opportunity Credit as well.
10. SECTION 45E CREDIT: Starting in 2010, Employers get a partial credit for health insurance paid for employees. Read Notice 2010-44 for guidance and rules.
11, FUTURE TIME BOMBS IN HEALTH CARE ACT: Start thinking about the new surtax on unearned income in 2013 and the presumptive earned income rules for LLC and decide how to optimize and consider whether LLC’s need to be converted to Limited Partnerships.