Why is this Topic Important to Wealth Managers?  A producer should be able to present a perspective of the potential impact of current budget proposals upon investments that will be realized in the future.  Thus, Advanced Market Intelligence discusses certain features to the proposed federal budget that impact fiscal year 2012.

The President’s new budget proposal included many revenue raising measures.  However, below are two areas affecting the tax code that will actually increase the deficit, and also have a strong likelihood to have an impact on clients’ decisions made today.

Currently, the maximum rate of tax on the qualified dividends and net long-term capital gains of an individual is 15 percent. [1] In addition, any qualified dividends and capital gains that would otherwise be taxed at a 10- or 15-percent ordinary income tax rate are taxed at a zero percent rate.

The zero- and 15-percent rates for qualified dividends and capital gains are scheduled to expire for taxable years beginning after December 31, 2012. [2] In 2013, the maximum income tax rate on capital gains would increase to 20 percent (18 percent for assets purchased after December 31, 2000 and held longer than five years), while all dividends would be taxed at ordinary tax rates of up to 39.6 percent.

Taxing qualified dividends at the same low rate as capital gains for all taxpayers is said to reduce the tax bias against equity investment and promote a more efficient allocation of capital.  Eliminating the special 18-percent rate on gains from assets held for more than five years is thought to further simplify the tax code.

The Administration’s revenue baseline budget assumes that the current zero- and 15-percent tax rates for qualified dividends and net long-term net capital gains are permanently extended for middleclass taxpayers.   In addition, the proposed budget would apply a 20-percent tax rate on qualified dividends that would otherwise be taxed at a 36- or 39.6 percent ordinary income tax rate.  This is the same rate as will apply to net long-term capital gains for upper-income taxpayers under current law after 2012.  The reduced rates on gains from assets held over five years would be repealed.  The special rates applying to recapture of depreciation on certain real estate (Section 1250 recapture) and collectibles would be retained.

This proposal would be effective for taxable years beginning after December 31, 2012, and would increase the deficit by $9.582 billion in 2013.

Secondly, the President’s budget calls for the repeal of information reporting on payments to corporation and payments for property (an issue that has been the topic of much discussion lately).

Generally, a taxpayer making payments to a recipient aggregating to $600 or more for services or determinable gains in the course of a trade or business in a calendar year is required to send an information return to the Internal Revenue Service setting forth the amount, as well as name and address of the recipient of the payment (generally on Form 1099). [3] Under a longstanding regulatory regime, there were certain exceptions for payments to corporations, as well as tax-exempt and government entities.  Also, this information reporting requirement did not apply to payments for property.

Effective for payments made after December 31, 2011, the Affordable Care Act expanded the information reporting requirement to include payments to a corporation (except a tax-exempt corporation) and payments for property.  [4]

Generally, compliance increases significantly for payments that a third party reports to the IRS.  In the case of payments to tax-exempt or government entities that are generally not subject to income tax, information returns may not be necessary.  On the other hand, during the decades in which the regulatory exception for payments to corporations has become established, the number and complexity of corporate taxpayers have increased.  Moreover, the longstanding regulatory exception from information reporting for payments to corporations has created compliance issues.   In addition, the expanded information reporting requirements imposed by the Affordable Care Act is expected to put an undue burden on small businesses.

The proposed budget would repeal the additional information reporting requirements imposed by the Affordable Care Act.  Further, the proposal would require businesses to file an information return for payments for services or for determinable gains aggregating to $600 or more in a calendar year to a corporation (except a tax-exempt corporation).  Information returns would not be required for payments for property.

This proposal would be effective for payments made after December 31, 2011, and have a net increase of the deficit in 2012 of $475 million.

Tomorrow’s blogticle will continue with discussion on the national budget.

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

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[1] See generally, 26 U.S.C. § 1(h).

[2] See Section 102 of The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (HR. 4853).

[3] See Internal Revenue Code Section (IRC) 6041, Treasury Regulations (TR) 1.6041-1(a)(1)(i), TR 1.6041-1(a)(2).

[4] See Patient Protection and Affordable Care Act, 124 Stat. 1029.  §9006 (a).

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).