In a tax plan full of surprises, President Obama’s unexpected proposal to give workers a one-year, 2 percent Social Security tax holiday is perhaps the most surprising part.   But Social Security experts caution workers not to party just yet because the holiday could destabilize Social Security.   And, although a 2 percent paycheck bump is better than nothing, it is not the tremendous boon to workers it is being presented as.  The Social Security tax holiday would essentially offset the loss of the Making Work Pay tax credit, which expires at the end of 2010 and is not renewed by the tax cut bill.  The Making Work Pay tax credit gives taxpayers making at least $5,000 and no more than $75,000 annually a refundable $400 tax credit.

Opponents also characterize the proposed tax holiday as an attempt to shift retirement savings from the Social Security Administration to Wall Street.  Undoubtedly, many taxpayers will, smartly, divert the 2 percent tax break into their 401(k)s and IRAs, but a majority of taxpayers are likely to spend the money, barely noticing the tiny bump in their paychecks.  Read this complete article at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of the debate over the expiring Bush tax cuts in Advisor’s Journal, see Obama Tax Agreement Faces Stiff Resistance in Congress (CC 10-112) and What Lies Beyond the Sunsetting 2010 Tax Provisions (CC 10-88).

Why is this Topic Important to Wealth Managers? Discusses Internal Revenue Code Section 179 in relation to the Obama Tax Cuts.  Presents analysis of a common transaction used by small business when acquiring capital assets.

Last month we discussed Section 179 in conjunction with year-end tax planning.   As a general matter of review, businesses may take “annual deductions for depreciation and amortization to the extent they represent a reasonable allowance for the exhaustion, wear and tear of property used in a trade or business or held for the production of income.” [1] This concept is based on the matching of the actual use of the property as a deductible expense.

However, earlier this year, Congress enacted the Small Business Jobs Act of 2010, [2] which included several changes in areas concerning the tax law, in part regarding Section 179. [3]

Specifically, the Small Business Jobs Act, “increased the maximum amount deductible under [Internal Revenue Code] Section 179 which allows, under certain situations, for the expense of generally depreciable assets.” [4]

Therefore, subject to certain limitations, a taxpayer that invests in certain qualifying property may elect under section 179 to deduct (or “expense”) the cost of qualifying property, rather than to recover such costs through annual depreciation deductions occurring over the useful life of the asset.

As was discussed in an earlier blogticle, for taxable years beginning in 2010 and 2011, the maximum amount that a taxpayer may expense is $500,000 of the cost of qualifying property placed in service for the taxable year.  The $500,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $2,000,000. [5]

Section 402 of the Tax Relief, Unemployment Insurance Reauthorization, And Job Creation Act of 2010 [6], amended certain deductible amounts with regards to section 179 that become effective beginning in 2012.

The new law states that, for taxable years beginning in 2012, the maximum amount a taxpayer may expense, under Section 179, is $125,000 of the cost of qualifying property placed in service for the taxable year. The $125,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $500,000.

Furthermore, the new law states that, for taxable years beginning in 2013, and thereafter, the maximum amount a taxpayer may expense under Section 179 is $25,000 of the cost of qualifying property placed in service for the taxable year.  The $25,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $200,000.

Tomorrow’s blog will continue to discuss pertinent provisions of the new Tax Cuts.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] AdvisorFX.  Business Income and Deductions (AUS Main Section 19, B4). http://www.advisorfx.com/articles/f19_1_8_3260.aspx?action=13.  Citing, 26 C.F.R. §1.167(a)-1, 26 U.S.C. §§167, 168, 169, 179 and related regulations.

[2] H.R. 5297.  http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=111_cong_bills&docid=f:h5297enr.txt.pdf.  Last Accessed 11/8/2010.

[3] H.R. 5297. Section 2021.

[4] Business West. Year-end Tax Planning.  http://businesswest.com/2010/11/year-end-tax-planning. 09 November 2010.   Last Accessed 11/8/2010; 113 Journal of Taxation 195.

[5] 26 U.S.C. § 179 (b)(1)(B).

[6] HR. 4853.

Taxpayers who want to come clean with the IRS about offshore assets may get a second chance.

Although taxpayers with undisclosed offshore accounts cannot count on getting deals like those offered under previous voluntary disclosure programs, a new program is in the works. A new disclosure regime will also be available to the 3,000 plus taxpayers who came forward after the October 2009 expiration of the previous disclosure program.

The numbers back up the Commissioner’s confidence, with a total of 18,000 taxpayers with undeclared offshore assets coming forward since the earlier disclosure program was launched.  The program enticed taxpayers to reveal themselves by offering significantly reduced penalties to taxpayers who voluntary disclosed previously undisclosed offshore assets.

The new voluntary disclosure program will still offer decreased penalties for those who voluntarily declare their offshore assets to the IRS, but penalties will be stiffer than those offered under the former program.  Read this complete article at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of FATCA in Advisor’s Journal, see Offshore’s Limited Shelf Life (CC 10-47)and IRS Proposed FATCA Guidance Expands Offshore Compliance Initiatives (CC 10-52).

Why is this Topic Important to Wealth Managers? Discusses Social Security Employee and Self-Employment tax rate reductions as enacted by the Obama Tax cuts.

Section 601 of The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (HR. 4853) provides for employee tax and self-employment tax rate reductions.

The Social Security tax is divided by the employee and employer share. [1] For self-employed individuals, a separate but comparable tax applies to covered wages.  [2]

For employees, generally, the term covered wages in this context means, all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash. [3]

Social Security is generally taxed at 6.20% and Medicare (Hospital Insurance) 1.45%. [4] Social Security taxes are composed of (1) the old age & survivors insurance (5.30%) and (2) disability insurance (0.90%) (together known as “OASDI”) tax equal to 6.2 percent of covered wages up to the taxable wage base ($106,800 in 2010 and again in 2011); and (2) the Medicare hospital insurance (“HI”) tax amount equal to 1.45 percent of covered wages. [5]

However, under the new legislation, the employee OASDI tax rate under the Social Security tax is decreased by two percentage points to 4.2 percent for next year only. [6] The employer contribution rate will not change.

Further, under the self-employment tax, the OASDI tax rate is decreased by two percentage points to 10.4 percent for taxable years that begin in 2011.  This reduction is from the normal 12.4 percent, which is equal to the combined employee and employer OASDI FICA tax rates, and applies to self-employment income up to the FICA taxable wage base.  Similarly, the rate of the HI portion is 2.9 percent, the same as the combined employer and employee HI rates under the FICA tax.

Generally, a self-employed individual may deduct half of the combined OASDI and HI rates, or 7.65%, in the determination of adjusted gross income. [7]

Under the new law, the rate reduction is not taken into account for the determination of the deduction.  Further, to compensate for the income tax deduction allowed under Internal Revenue Code Section 164(f) for taxable years beginning in 2011 will be computed at the rate of 59.6 percent of the OASDI tax paid, plus one half of the HI tax paid.

The Social Security tax cuts come at an interesting time. The 2010 Social Security Trustees Report [8] projects under its “intermediate” cost scenario, notwithstanding the new decrease in Social Security tax, that by the end of 2010 the total cost of the OASDI and HI tax (Social Security) and liabilities will equal a shortfall of approximately $74 Billion.  By 2020 the deficit is estimated to be around $100 Billion.  In just 30 years, by 2040 the total annual unfunded cost will be approximately $1 Trillion dollars.  The administrative costs alone in 2009 for OASSDI, according to the Trustees Report, was over $6.18 Billion.

Tomorrow’s blog will continue to discuss pertinent provisions of the new Tax Cuts.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] 26 U.S.C. § 3101.

[2] 26 U.S.C. § 1401.

[3] 26 U.S.C. § 3121.

[4] 26 U.S.C. § 3111.

[5] 26 U.S.C. § 3111.

[6] HR. 4853, Sec 601.

[7] 26 U.S.C. § 1402 (a)(12).

[8] The 2010 Annual Report of the Board of  Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Fund.  111th Congress, 2d Session .  House  Document  111-137.  http://www.ssa.gov/OACT/TR/2010/tr2010.pdf.  Last Accessed 12/20/2010.

Life settlement funds’ fees are coming under scrutiny, with some funds charging performance fees as high as 75 percent.

Life settlement funds—which purchase life insurance policies from the sick and elderly and collect death benefits when the insureds die—can offer consistent, uncorrelated returns but also pose significant risks to investors due to their cash flow needs and the uncertainty of returns on life insurance policies.  These risks are further exacerbated when funds charge excessive fees. And many funds are unregulated offshore entities—which adds an additional set of risks.  Read this complete article at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of life settlements in Advisor’s Journal, see NCOIL Adopts Model Act Requiring Insurers to Inform Consumers of Settlement Options (CC 10-104), New York Court of Appeals Upholds STOLI Arrangement (CC 10-106), and Should the Basis of a Life Contract be Adjusted by Mortality Charges? Rev. Rul. 2009-13 Says Yes in Context of Life Settlements; Certain Amounts over Adjusted Basis Treated as Capital Gains (CC 09-19).

Author: William H. Byrnes & Benjamin S. Terner

Why is this Topic Important to Wealth Managers? Yesterday we presented an overview of the Obama Tax Cut provisions that are relevant to wealth managers.  Today we begin by taking a closer look at some of the details of those provisions and how they relate to wealth managers and their clients.

Section 102 of The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (HR. 4853) provides for an extension of the regular and minimum tax rates for qualified dividend income and capital gains as were in effect before 2011.  The extension will continue for an additional two years.

To understand the impact of this provision of the new bill, it will serve the reader to understand what the regular and minimum tax rates in relation to qualified dividend income as well as capital gains means.

Qualified Dividends

Before the passage of the second major tax cut enacted by the prior administration, The Jobs and Growth Tax Relief Reconciliation Act of 2003, dividends were taxed as ordinary income, and at ordinary income tax rates, to the taxpayer.  With the passage of Section 102 of the Obama Tax Cuts, the determination of tax liability with regards to qualified dividend income is taxed at the same rates as net capital gains.

Therefore, under Internal Revenue Code § 1(h), qualified dividends are tax at zero and fifteen percent.  Qualified dividends that would be taxed as ordinary income at an otherwise 10-15% rate, are taxed at zero percent, and qualified dividends that would ordinarily be taxed as ordinary income at 25% are taxed at a maximum of 15%.

Qualified dividend income, for this purpose means, dividends received during the taxable year from domestic corporations, and qualified foreign corporations.[1]

One important rule to note with regards to qualified dividend income is that shareholders must hold a share of stock for more than 60 days during the 121-day period beginning 60 days before the ex-dividend date to be eligible for the reduced tax rates. [2]

Ex-dividend date generally means “the date on which the share of stock becomes ex-dividend”. [3] In other words, when a stock corporation declares a dividend, it also states the date of record, upon which the shareholder must own the stock on the company books to be paid the dividend.   “Once the company sets the record date, the stock exchanges or the National Association of Securities Dealers, Inc. fix the ex-dividend date. The ex-dividend date is normally set for stocks two business days before the record date.” [4]

Capital Gains

With the extension of the Tax Cuts, the maximum tax rate on the adjusted net capital gain of a taxpayer is 15%. [5] Adjusted net capital gain means the sum of:

(A) net capital gain (defined below and determined without regard to the calculation of adjusted net capital gain) reduced, but not below zero, by the sum of:
(i) any unrecaptured Section 1250 gain, and
(ii) 28-percent rate gain, plus
(B) qualified dividend income.  [6]

Net capital means the excess of the net long-term capital gain for the taxable year over the net short-term capital loss for such year.[7] Qualified dividend income was defined above and has the same meaning as applied here.

Section 1250 gains and 28-percent rate gains are defined in Internal Revenue Code Section 1(h) but are beyond the purview of this blogticle.  For additional discussion on Section 1250 and 28-percent rate gains see TAXFACTS 7524:  How is an individual taxed on capital gains and losses? Accessible through AdvisorFX with your online subscription.  For a free trial see AdvisorFX.

Tomorrow’s blog will continue to discuss pertinent provisions of the new Tax Cuts.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] 26 U.S.C. § 1(h)(11)(B).

[2] 26 U.S.C. § 1(h)(11)(B)(iii).

[3] 26 U.S.C. § 1059(d)(4).

[4] Securities and Exchange Commission.  Ex-Dividend Dates: When Are You Entitled to Stock and Cash Dividends. http://www.sec.gov/answers/dividen.htm.  Last Accessed 12/19/2010.

[5] HR. 4853, Section 102; 26 U.S.C. § 1(h).

[6] 26 U.S.C. § h(3).

[7] 26 U.S.C. § 1222 (11).

Why is this Topic Important to Wealth Managers? Discusses relevant provisions of the “Obama Tax Cuts”.  Provides a topical overview of pertinent provisions for wealth managers.

On Friday, President Obama signed into legislation, what is quickly becoming known as the Obama Tax Cuts, which extend tax breaks initially created by the George Bush Administration about a decade ago.  For the previous discussions and various versions of this “long and winding road” of the passage of this new tax law – see Tax Deal Reached

The new tax law “The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (HR. 4853)“ provides an extension for two years (unless otherwise noted), of generally the following (not all inclusive):

The continuation of the 10, 15, 25, 28, 33, 35-percent regular income tax brackets.  Sec 101.

The continuance of the removal of itemized deduction limit and personal exemption phase-out.  Sec 101.

Child tax credit extensions along with increased earnings threshold for credit determination.  Sec. 101 and 103.

Increases the basic standard deduction for a married couples filing jointly to twice that of the standard deduction for unmarried individuals.  Sec 101

Extends certain earned income tax credit provisions including for determination of application of tax credit to income tax liability. Sec 101 and Sec 103.

Extends qualified dividend income taxable at net capital gains rates. Sec 102

Extends the maximum rate of tax on adjusted net capital gains to 15 percent. Sec 102.

Extends Hope and American Opportunity Tax Credit with regards to secondary education.  Sec 103.

Alternative Minimum Tax (AMT) exemption amounts for taxable years 2010; $72,450, for married filing jointly and $47,450, for unmarried individuals, and 2011; $74,450, for married filing jointly, and $48,450 for unmarried individuals. Sec 201.

The provision reinstates the estate and generation skipping transfer taxes with exclusion amount of $5 million, with a maximum estate tax rate of 35 percent.  Sec 301-304.

For gifts made in 2010, exclusion amount is $1 million, and the gift tax rate is 35 percent, for gifts made December 31, 2010, the gift tax is reunified with the estate tax, with an applicable exclusion amount of $5 million and a top estate and gift tax rate of 35 percent.  Sec 301-304.

The generation skipping transfer tax exemption continues in an amount of $5 million.  Generation skipping transfer tax rate for transfers made during 2010 is zero percent. The generation skipping transfer tax rate for transfers made after 2010 is equal to the highest estate and gift tax rate in effect for such year (35 percent for 2011 and 2012).  Sec 301-304.

Repeals the modified carryover basis rules—now a recipient of property acquired from a decedent will generally receive a “step-up” or fair market value basis. Sec 301-304.

Extends and expands the additional first-year depreciation to equal 100 percent of the cost of qualified property placed in service after September 8, 2010 and before January 1, 2012, and provides for a 50 percent first-year additional depreciation deduction for qualified property placed in service after December 31, 2011 and before January 1, 2013.  Sec 401.

Starting in 2012, the maximum amount a taxpayer may expense is $125,000 of the cost of qualifying property placed in service for the taxable year. The $125,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $500,000.  Sec 402.

Reduces the employee FICA tax by two percentage points for one year (2011 only). Also reduces self-employment taxes tax by two percentage points for taxable years of individuals that begin in 2011. Sec  601.

The Act extends the rules regarding contributions of capital gain real property for conservation/charity purposes for two years for contributions made in taxable years beginning before January 1, 2012. Sec 725.

We provide a link below to the actual Bill (now new law) that you may look at each section listed above after each change.  Then, we provide a link to the Congressional explanation of the changes:

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (HR. 4853) Bill: http://www.gpo.gov/fdsys/pkg/BILLS-111hr4853eas2/pdf/BILLS-111hr4853eas2.pdf Last Accessed 12/19/2010.

Joint Committee on Taxation.  Technical Explanation of the Revenue Provisions Contained in the “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010” Scheduled For Consideration By The United States Senate. JCX-55-10.  December 10, 2010.  Accessible through: http://www.jct.gov/publications.html?func=startdown&id=3716.  Last Accessed 12/19/2010.

Tomorrow’s blog will discuss certain provisions of the tax cuts in more detail.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

President Obama’s tax compromise—the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010—passed the House late Thursday (Dec. 16) by a margin of 277-148. The Bill, which was passed by the Senate on Wednesday (Dec. 15), was signed into law by President Obama.

The act, which extends the Bush tax cuts for two years for taxpayers at all income levels, includes the following provisions (among others):  Read this complete article at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of congressional wrangling over the Bush tax cuts in Advisor’s Journal, seeObama Tax Agreement Faces Stiff Resistance in Congress (CC 10-112), Lame Duck Agenda Packed with Tax Business (CC 10-108), Obama Administration May Be Willing to Extend Bush Tax Cuts for More Taxpayers (CC 10-93), and CBO Analysis Supports Extending Tax Cuts (CC 10-49).

The financial strength and claims-paying ability of an insurer is one of the first questions asked when trying to ascertain suitability of life insurance products.   However, financial strength and claims-paying ability ratings of the insurer are only one of at least five major suitability considerations and are often misunderstood to mean more than just the financial strength and claims-paying ability of the insurer.  For instance, the answer to the question: “Is this a good product?” is all too often “Yes, the company is highly rated.”

An insurer that is highly rated for financial strength and claims-paying ability does not necessarily mean that every product they manufacture is suitable for every age/gender combination, every health risk class, every policy size, every product type, or every funding strategy. In the same way that no investment company offers the best investment products for every client situation, no life insurance company offers products that are best in all client situations. Instead, certain life insurers excel in manufacturing products that are particularly competitive in certain client situations just like certain investment companies are known for certain types of mutual funds.  Read this complete article at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of the suitability standard in Advisor’s Journal, see Life Insurance Product Suitability (CC 10-90).

We invite your questions and comments by posting them in our blog AdvisorFYI or by calling the Panel of Experts.