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Coming Tax Changes for 2013

By David L. Blain, CFA

There are several significant changes to the tax code that will take effect in 2013. These changes revolve around two main events:  (1) previously scheduled increases in investment and marginal income tax rates, and (2) implementation of several new taxes enacted in prior years.

NOTE:  Some or all of the changes discussed below will more than likely change prior to filing 2013 taxes in the spring of 2014.

As a firm, we’ve already started tax planning for our clients, and as a thought leader in the community on tax issues, we think it’s important to share this information with our friends and colleagues. To make that easier, we’ll separate the changes into bite-sized chunks of similar provisions.

New Taxes

Effective January 1, 2013 several new forms of taxation will be in place, including the following:

Medicare surtax–The current individual Medicare tax on earned income is 1.45% (your employer also contributes 1.45% of your wages). Under the new law, if you make more than $200,000 ($250,000 for joint earners) you will pay an additional 0.9% for a total of 2.35%.

NOTE:  Individuals who operate their business as a sole proprietorship, partnership, or LLC taxed as either a sole proprietorship or partnership, will pay a total of 3.8%.

Surtax on investment income–If Congress extends the current law passed in 2010, those of you who have modified adjusted gross income (MAGI) of $200,000 or more (again, $250,000 for joint earners) will be assessed a 3.8% surtax on investment income including dividends, interest, capital gains, rental income, etc.

NOTE:  If you are a passive investor in a private business, the surtax rules become quite complex. Please contact our office for an individualized discussion of this new tax.

Tax on “Cadillac” healthcare plans–Employer-paid comprehensive healthcare plans costing more than $10,200 for individuals or $27,500 for family coverage, will be charged a 40% tax on the amount the employer pays.

Tax on medical devices–Manufacturers of medical equipment will pay a 2.3% excise taxes on all devices costing $100 or more.

Cap on Flexible Spending Accounts (FSAs)–Beginning in 2013, FSA contributions will be capped at $2,500. Currently, there is no cap.

Penalty for non-medical withdrawals from Health Savings Accounts (HSAs)–The penalty for making a non-medical withdrawal from your HSA has doubled from 10% to 20%.

Itemized deductions for medical expenses–The threshold for claiming medical and dental expense deduction will be increasing from 7.5 percent of AGI to 10 percent (the 7.5 percent will remain in effect for taxpayers 65 years or older through 2016).

Penalty tax for not buying insurance–Starting in 2014, if you decide not to buy health insurance, you will be assessed a tax of between $95 and $5,000, depending on your income (see sidebar). The minimum tax goes up to $695 in 2016.

As always, there are exemptions and exceptions for the tax changes mentioned above.

Personal Income Tax

Personal incomes taxes will go up in several different ways. Most of the changes begin for tax year 2013. Let’s take a look.

Tax brackets–Tax brackets will go up across the board (see Table). But, the lowest bracket would go up 50% while the highest bracket would rise only 13%. That’s a huge burden for those who can scarcely afford it.

Itemized deductions–The majority of itemized deductions will be reduced to 3% of adjusted gross income (AGI)—above an inflation-adjusted threshold (estimated to be $174,450 for all taxpayers except those married filing jointly)—or 80% of all allowable deductions, whichever is less.

Personal exemption–Under current law, high earners receive a $3,800 personal exemption for each taxpayer, their spouse (if filing jointly) and children/other dependents. For tax year 2013, taxpayers filing jointly with inflation-adjusted AGI over $261,650 ($174,450 for individuals) will no longer receive the personal exemption.

Marriage penalty–The standard deduction currently enjoyed by married taxpayers filing jointly is 200% of the standard deduction for individual taxpayers. That goes down to 167% next year.

Child credit–The child credit will be reduced to $500 from the current $1,000. Also, the credit cannot be used to offset alternative minimum tax (AMT).

Student loan interest deduction–The deduction for student loan interest will apply only to interest paid during the first 60 months in which it is required. Under current law, there is no such time limitation. Also, the deduction will phase out for lower AGI payers. These amounts are projected to be $75,000 for joint filers and $50,000 for all other filers.

Household and dependent care credit–The credit given for household and dependent care expenses will go from $3,000 to $2,400 for one qualifying individual and $6,000 to $4,800 for two or more qualifying individuals. Also, the maximum credit will decrease from 35% to 30% of creditable expenses. Finally, the reduction in the credit (based on AGI) will begin at $10,000 instead of the current $15,000.

Home sale exclusion–The current home sale exclusion of $250,000 will no longer be available to heirs, estates or qualified revocable trusts after the sale of a decedent’s home.

Deduction for educational assistance–Employees will no longer be able to deduct the amount of employer-provide educational assistance directly from their income.

Taxes on Investment Income

Taxes on investment income will go up on several fronts, most notably on capital gains and dividend income.

Capital gains tax–For most investors, the tax rate on long-term capital gains will increase from 15% to 20%. Investors in the 10%-15% brackets do not pay tax on dividend income right now, but they will be subject to a 10% tax beginning in 2013.

Dividend income–Dividend income is currently taxed at either a 15% or 35% rate. Next year, all dividend income will be subject to a 39.6% tax rate.

Business

Changes to business-related taxes will be fairly dramatic next year. This includes changes to depreciation allowances, taxes on medical equipment, the withholding rate for unemployment benefits and S corporation taxation, just to name a few.

Depreciation expense–For tax year 2013, businesses will still be able to expense certain depreciable assets (machinery, equipment, computer software, etc.) for the tax year in which they are placed into service. However, the amount that can be expensed will again be subject to an investment ceiling. Both will go down in 2013 from the current $139,000 and $560,000, to $25,000 and $200,000, respectively.

Backup withholding–Backup withholding rates* relating to dividend and interest income will go up to 31% from 28%. For employers using the flat rate method, withholding rates for wages up to $1 million will go from 25% to 28%, and for wages over $1 million, the rates will go from 35% to 39.6%. Employers will also see the voluntary withholding rate for unemployment benefits will go from 10% to 15%.

S corporations–If you converted your business from a C corporation to an S corporation, you have potential exposure to a 35% built-in gains (BIG) tax. Whether or not you owe a BIG tax depends on the value of the corporation’s assets on the day of conversion and when the anniversary date falls in relation to the end of the corporation’s fiscal year.

*Backup withholding for employees typically applies when W-9 information does not match IRS records, if dividend and interest income is not reported, or if federal income tax is owed.

Needless to say, it is a very challenging environment for tax planning as we head into 2013. Now more than ever it is extremely important to plan ahead and not wait until April 2014 to find out which of the new taxes apply to your particular situation.

Influence Peddling and Corporate Profit

As it turns out, lobbying organizations and influence peddling play a big role increasing corporate profits.

Research from Strategas Research Partners shows that corporations that spend big bucks on lobbying reap bigger investment returns on their stocks.

Unfortunately, the researchers don’t reveal the names of the 50 biggest spenders, so picking stocks based on this information is difficult beyond measure.

They do say that companies that benefit most from lobbying are in heavily regulated industries such as medical, energy and defense.

Their lobbying index has outperformed the major indices for years, but trying to pick the winners on such scant information is a fools errand.

The research does hint at the value of having a good financial advisor. A good advisor doesn’t look for quick hits like the companies discussed above. A good advisor will help you organize your finances so that your wealth works more efficiently for you in the long run.

The Importance of a Good Financial Advisor

It’s important to have a financial advisor to help simplify and manage your personal finances including your investment portfolio.

But you need to realize when choosing an advisor that they don’t have any magic bullets to save on taxes or grow your portfolio.

The real value in an advisor is the knowledge and experience they bring to help you organize and simplify your financial life.

If done correctly, this process can improve your investment return, save you money on taxes, and better manage your personal finances.

When it comes to your portfolio, keep in mind that long-term success is determined by effectively managing your risk by diversifying and allocating your holdings across multiple asset classes, sectors and global regions. A good advisor can do this for you.

While some people have the ability to manage their own portfolio, the average investor does not. They tend to act based on fear and greed, not good information. And, they tend to change investment styles too often instead of sticking with a philosophy that has proven to be successful over long periods of time.

The Value We Bring

It’s important to understand the value that a competent and reliable financial advisor brings to the wealth management table.

First, a good advisor will help you organize and simplify your finances so they perform more efficiently for you.

Also, a good advisor can construct a well allocated portfolio that will manage risk and grow your assets.

A good advisor will help you grow your savings, not make money. It’s a subtle distinction, but one that is critically important for long-term success.

Developing good savings habits to help grow your portfolio can’t be over emphasized.

A good advisor can help you develop a good long-term financial plan by identifying your goals and constructing a portfolio that will ensure you meet them.

A good advisor will provide good stewardship over your wealth so you don’t have to. Providing peace of mind is probably the most important thing a good advisor can do.

Uncovering The Value Of A Financial Advisor

As it turns out, lobbying organizations and influence peddling play a big role increasing corporate profits. Research from Strategas Research Partners shows that corporations that spend big bucks on lobbying reap bigger investment returns on their stocks.

The research does hint at the value of having a good financial advisor. A good advisor doesn’t look for quick hits like the companies discussed above. A good advisor will help you organize your finances so that your wealth works more efficiently for you in the long run.

The real value in an advisor is the knowledge and experience they bring to help you organize and simplify your financial life. If done correctly, this process can improve your investment return, save you money on taxes, and better manage your personal finances.

A good advisor will provide stewardship over your wealth so you don’t have to. Providing peace of mind is probably the most important thing a good advisor can do.

Historic Tax Rates and Tips for 2012

The modern income tax was started in 1913. The top rate was 7% and it applied to earners making more than $500,000. Prior to the war, the top rate was 79% on people earning more than $5,000,000. By World War II, the rate changed to 94% on incomes over $200,000. These changes demonstrate what’s known as “tax creep.”

We are facing historic tax rates and tax strategies are more important than ever to help lower your taxable income for 2012. But taxes are ever changing and get more complicated over time. This makes tax planning more and more challenging.

Not following IRS rules to the letter could land you in tax court. In tax court, taxpayers can be represented by CPAs, attorneys and enrolled agents.

Tax Strategies for 2012

We are facing historic tax rates and tax strategies are more important than ever to help lower your taxable income for 2012.

Top tax brackets have been coming down through the years. As a result, more and more tax payers have been moving into these higher brackets.

Also, the definition of income has changed over the years and that has affected a great number of taxpayers too.

The biggest problem with taxes is that they are ever changing and get more complicated over time. This makes tax planning more and more challenging.

Municipal bonds can provide tax advantages, but picking the right ones can be tricky. It depends on where you live and what kind of rating your state’s bonds receive.

Real estate can be an invaluable tool to limit tax liability, but it must be managed carefully. First, it’s important to understand that a house is really a place to live, not an investment.

And, even though you can pocket profits from the sale of a home that are free of capital gains taxes, constantly buying and selling homes to accomplish this could drive you crazy.

Another thing to consider is maxing out your Roth IRA, especially if you are getting close to retirement. A 529 plan to save money for your children’s retirement may be something to consider as well.

A History of Income Tax Rates

The modern income tax was started in 1913. The top rate was 7% and it applied to earners making more than $500,000.

By World War II, the rate changed to 94% on incomes over $200,000. Prior to the war, the top rate was 79% on people earning more than $5,000,000.

These changes demonstrate what’s known as “tax creep.” This occurs when the highest rate begins to apply to lower and lower income levels (from $5,000,000 to $200,000 for example).

But, targeting specific groups with higher tax rates doesn’t work.

Tax Courts and IRS Rules

Not following IRS rules to the letter could land you in tax court. In tax court, taxpayers can be represented by CPAs, attorneys and enrolled agents. This taxpayer needed representation after the IRS got through with them!

A charitable contribution to a church was rejected by the IRS because the documentation was incorrect.

The taxpayer had the church provide reasonable documentation and the whole thing was represented to the IRS.

This too was rejected by the IRS because it wasn’t “contemporaneous” (a fancy word for timely).

The bottom line is that the deduction was rejected and the taxpayer didn’t receive the benefit.

The IRS can also rule against you if they feel your deduction doesn’t meet the spirit of tax law as they see it. This is usually overruled upon appeal.

Planning for a Health Crisis

In this article from Dow Jones Newswires, David L. Blain, CFA, discusses the importance of planning for a potential health crisis within his wealth advisory firm.

D.L. Blain & Co. Receives National Recognition

FOR IMMEDIATE RELEASE

Contact: Jeb Collier

Telephone:  (252) 633-0107

Email:  jebcollier@dlblain.com

 NEW BERN WEALTH MANAGEMENT FIRM RECEIVES NATIONAL RECOGNITION

D. L. Blain & Co. In Top Registered Investment Advisor Survey From Financial Advisor Magazine

New Bern, NC (July 11, 2012) – D. L. Blain & Co. is pleased to announce that it has been included in Financial Advisor magazine’s 2012 Survey of the top Registered Investment Advisor (RIA) firms in the U.S. Inclusion in this year’s survey marks the third time D. L. Blain & Co. has been named to this prestigious list.

Financial Advisor annually publishes its survey of the top RIAs in the country based on assets under management. To be considered for the 2012 survey, firms must be RIAs and provide financial planning and related wealth management services to their clients. All firms must be either independently owned or be a freestanding subsidiary of another business. Trust companies, banks and broker/dealers were ineligible.

Financial Advisor magazine reaches more than 90,000 readers each month and delivers essential market intelligence that advisors need to succeed in the increasingly complex environment of wealth planning.

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Financial Fraud, Fees and Retirement

States pay billions of dollars in fraudulent and erroneous unemployment benefits each year. Perhaps if the fraudsters put their energies into legitimate work, the unemployment rate may go down!

It’s critically important to understand what fees-including commissions-you are paying in association with financial advice you receive.

You should avoid these common retirement pitfalls if you are to be financially successful.

Avoid These Retirement Pitfalls

You should avoid these common retirement pitfalls if you are to be financially successful.

People come in to our office every day who with a little guidance can retire successfully.

But there are questions you need to ask yourself as you contemplate retirement.

First, can you afford to retire? What will your income be in retirement? Chances are you won’t earn what you were when you were working.

And, there’s a chance some of your expenses might increase (like higher costs for healthcare). You need to look at your potential income realistically.

Make sure you have a plan. Knowing where you are going and how you will get there is key.

For example, don’t stop investing. People holding too much cash will miss opportunities to grow their wealth, especially during inflationary times.

Also, make sure you have the right accounts for retirement. Organizing and simplifying your wealth will be a great benefit.

Make sure your portfolio is properly allocated to meet your investment needs during retirement. Allocation for accumulation can be quite different from allocating for retirement.

The bottom line is, organize and simplify your wealth so that it works more efficiently for you throughout your retirement years.

Unemployment Benefit Fraud

States pay billions of dollars in fraudulent and erroneous unemployment benefits each year. Perhaps if the fraudsters put their energies into legitimate work, the unemployment rate may go down!

In 2011, states made $14 billion in overpayments to unemployment recipients, 11 percent of which were fraudulent. Part of this is due to bureaucratic error and the rest was fraud.

The big 3 of fraud are:  claims filed by those who aren’t actively searching for work, those who are fired or quit voluntarily, and those who continue to file even after they find work.

An inmate in Indiana was caught when he used the girlfriend of a fellow inmate to continue to file his former unemployment benefits.

Clean up the fraud and save billions.

Fee for Service: Know What You’re Paying

It’s critically important to understand what fees-including commissions-you are paying in association with financial advice you receive. After all, fees and commissions eat into the returns you earn on investments recommended by the advisor.

When seeking advice, ask the advisor to give you a full accounting of all costs related to that advice so that you can determine whether or not he or she is providing value.