New Taxes Arrive for Health Care

As I write this, serious talks are (hopefully) happening in Washington DC on a number issues collectively referred to as the "fiscal cliff." There are some important issues there, and a solution will not be easy. It will undoubtedly include both cuts in benefits (i.e., spending) and increases in taxes.

But we have a new tax increase about to take effect. The Affordable Health Care Act included a 3.8% tax on the "wealthy" to help pay for the expanded benefits. In general this is a Net Investment Income Tax (NIIT) on non-earned income over $200,000 for singles and $250,000 for couples. The issue is what is included in that list? While this is not an exhaustive list, it should give you a good feel:

• Interest and dividends
• Capital gains from the sale of stocks, bonds, and mutual funds (including capital gain distributions from mutual funds)
• Net income from rentals
• Gains from sale of interest in partnerships and S-Corporations if you were a passive owner
• Gain from the sale of investment real estate -- potentially including your residence!

The tax is 3.8% on the amount of gain that causes your taxable income to exceed the appropriate limit (e.g., $250,000). It is worth looking at that real close when we think about the sale of our homes.

First, it is only on gain. So if you purchased your house for $100,000 and sold it for $250,000 then you only have $150,000 of gain. The full $250,000 was never a consideration.

Second, under certain conditions, we are allowed to exclude from taxation a portion of the gain on the sale of our primary residence. For a single taxpayer that is $250,000, and for a married couple filing jointly that is $500,000. Since that gain exclusion is not taxable, it too is not subject to the 3.8% NIIT. The qualifiers are having owned and lived in the residence for 2 out of the last 5 years.

For example, if you paid $100,000 for that house 13 years ago and have lived in it the whole time, you sell it for $650,000, and you are filing a joint return, then $650,000 - $100,000 - $500,000 = $50,000. So it is possible that you could pay the tax on the $50,000 of excess income. But we still have not applied to total income test. So further assume that with the gain on the old house the total taxable income on the tax return comes to $260,000. That means the 3.8% NIIT will be applied to $10,000 only, or an additional $380 in income tax.

There are numerous fine points to the rules, and the list above is not all-inclusive. So it is important that each person seeks competent tax help. But this should give a general understanding for most situations.

Christmas Gift for Your Pastor

Ah, the holidays are upon us. Last this week most of us gathered with family or friends for the stated purpose of acknowledging how God has blessed us over the last year. Then we shared a meal together that suggests we think we will never eat again. But this isn't very tax related....

It will soon be Christmas, and the family memories will hopefully continue to grow. One common practice is to acknowledge how our pastors have blessed us over the year, and often that is done with some monetary gift. While the mechanism varies a bit from church to church, parishioners one way or the other give money through their church. The church office combines the gifts and the pastor (or pastors) receive a nice Christmas bonus.

A key word here is "bonus" as, like it or not, this represents taxable income to the pastor. Yes, I realize that the money originated from the gifts of those in the church, but doesn't most of the money to operate the church and pay the pastor's compensation originate from similar gifts?

These gifts do not have to be taxable compensation. The best way to avoid taxation of that money for your pastor is to simply hand the money to your pastor directly. As long as your total gifts personally to your pastor throughout the year stays below the gift limit ($13,000 for 2012) then there is nothing to worry about.

Sometimes people object to this because by giving the money directly to their pastor, they reason, they do not get a tax deduction for the gift. They are correct. But what is motivating the "gift" in the first place? Besides, when they give money to their church for the "pastor's gift" that is a contribution that is designated for a specific individual and is therefore not tax deductible anyway. (There are other rules for handling support of missionaries and "love offerings" for guest speakers that will remain outside the limits of this article.)

So just enjoy the holidays. Let your personal gifts be personal gifts, and take pleasure only in the genuine response or the benefit enjoyed by the person who receives your gift. And while you're at it, make an extra contribution to your church as well. Rarely is there a church who cannot put that to good use.

Mileage Rates for 2013

Today the IRS issued the new mileage rates for 2013. This is the amount that can be deducted per mile for various uses of your vehicle.

The new rate for business use is $0.565 per mile, up 1 cent from 2012. Of that amount, $0.23 remains the amount allocated for depreciation or basis reduction. What that means is that for every 100 miles you drive in 2013 (or 2012 for that matter) you must reduce your "basis" in the vehicle by $23. If you have enough miles, your basis might be reduced to the point that you must report the income if you sell your car.

For an example on the basis reduction, let's assume you paid $10,000 for your car. You drove this a lot for business purposes and the basis reduction came to $9,000 total over the several years you owned the car. Now you sell your car for $1,500. Think you "lost" $8,500 on the car? Guess again. You actually gained $500 on the sale and that income is taxable. Remember, you previously reduced your income by $9,000 so it is time to pay part of that back.

By the way, if you trade that car in on the purchase of a different car, that is actually considered a "1031 exchange" and you must file the appropriate forms with your tax return. That will avoid paying the tax on the $500 gain for now, but it reduces the basis on those new wheels.

The mileage rate for charity work remains at $0.14 per mile. That amount was set by Congress without allowing any authorization for adjustment due to inflation, etc. So until Congress changes it - it isn't changing.

For medical purposes or if you are moving the new rate is $0.24 per mile. That does not require basis adjustments on the vehicle.

Delayed Tax Season - Again?!

Last Friday acting IRS Commissioner Steven Miller sent a very clear warning to Congress. Unless an AMT patch is passed (and signed by President Obama) by December 31, the income tax filing season will be seriously impacted. Commissioner Miller states that approximately 60 million taxpayers will be impacted by the delay, and that is almost half the individuals who file a tax return.

Of particular note is that if Congress allows this to slide into 2013, the collision of needed programming changes and the processing of simple returns could delay the ability for these 60 million taxpayers to file their tax returns until late March! It is possible that taxpayers who itemize deductions could be included in that delay. This is presumably because the AMT system treats itemized deductions differently. Thus the processing of itemized deductions (Schedule A) requires "hooks" in the software to capture and treat items differently. Regardless of the details, the interaction is significant enough that we are being warned of a potential delay.

The estimated number of taxpayers that would escape paying AMT if an expected patch is made into law is 28 million.

Last year approximately 130 million individual tax returns were filed. Thus a little more than 1 out of 5 taxpayers have reason to fret over being dragged into "AMT Land" while hoping that Congress will grant a reprieve.

Update: On December 19 Mr. Miller again contacted Congress and updated his information. He now predicts that the number of taxpayers that will be prevented from filing until very late is in the 80-100 million range. This updated number also states about 150 million returns are expected to be filed. Furthermore, in order to guard against fraud, he indicates that all filing may be put on hold until this is resolved.

Another typical tax season on the calendar.....

Shock of shocks, there is another post to this blog. This blog may not receive much attention, but it does have better days coming.

Bloomberg reports that there are only 13 days between today and the election when both the Senate and House are in session. They also surmise what was obvious to me months ago - nothing related to our taxes, debt, etc. will happen until after the election. Both parties are hopeful that there negotiating position will be improved after the election.

So here's the scenario that we will live in a few months:

• Congress will extend some tax breaks for some group of people in December.
• The IRS will need to redesign multiple forms to conform to the legal changes. That will take much of December (if they get an early start) and part of January.
• Tax return processing software will need to be updated to match the new forms. That will likely not start until sometime in January.
• The 2013 filing season for 2012 taxes will begin with only the most simple of returns. Returns with many of the common but affected forms or schedules will not be able to be filed until sometime in February. (Wasn't it February 14 last year? Or was that the year before?)

Will the December changes solve our problems? No. It will only band-aid the situation, continuing to kick the can down the street. We cannot solve our fiscal issues without some combination of increased taxes and decreased benefits. And that does not lead to re-election. Thus there are few with the character to do what the country really needs.

Looks like it is going to be yet another typical year.....