Are you getting the most out of your accountant?

Often, clients put their accountants in a box like this and won’t let them out.  I have experienced this.  Once a client gets it in their head that “Polito is our tax guy”, it’s really hard to shake that image.   Our profession has so much more to offer!

When I was in the publishing business, before I knew what accountants did, I was the same way.  I called my accountant for tax stuff and little else.  I failed to take advantage of his years of knowledge and experience.  That business never flourished!

Many CPA’s start their careers as auditors for national firms auditing financial statements.  That is an extremely valuable experience.  Frequently, after between 2 to 5 years, these auditors  join public companies as controllers and chief financial officers….. and,  a significant number go on to become CEO’s of large public companies.  Indeed, there is a lot more to accounting than financial statement preparation and tax compliance!

About 10 years ago, we developed a service for a number of clients who had what I  term “technician syndrome”.  These clients  knew their particular trade or business and were fairly successful at it, but knew nothing about  the financial condition of their company.  They had no idea how they were really doing.  If there was cash in the bank, things were ok.  Actually, they were in a contest with their competitors but they weren’t keeping score!  In many cases, they didn’t understand the scoring system!

With the help of  my associates, I developed a series of graphs and reports tailored to each particular business.  We find elements of the financial records that if measured, could provide tools to gauge the success of various strategies.  We call these” Key Performance Indicators” (KPI’s).  We  model the effects of slight changes in these measures.  What would happen , for example if the company could increase margins by one percent?   What it would mean to the company, its owners, its employees, and other stakeholders.  We benchmark the clients by industry and size so they can see how they are doing compared to their peers.

We meet with these clients quarterly to go through the financial statements and the special reports that we designed specifically for that client.  At first, these meetings were the only time the clients seriously looked at their financial data. The meeting  is a really important part of this service.  It takes fairly deep study and analysis to really utilize the data.  This analysis coupled with the prodding of a seasoned professional outside the business, provides a stimulating atmosphere for new ideas on how to improve the business.  The brainstorming that goes on in these meetings is extremely valuable.

How do we use the data?

Using break-even analysis, we illustrate profitability scenarios.  We work with clients to develop budgets that support their strategies and we develop financial tools to measure the effectiveness of new strategies.  We develop forecasting models which our clients can use to project income and cash flow, and finally, we do tax projections with cash analysis so that the demand on cash for any suggested tax strategy can be quantified in cash required and cash saved.

To a non-accountant, this stuff is daunting.  I am convinced that one  reason some businesses can never “break through” to that proverbial “next level” is because they fail to make full use of their financial data.  By meeting regularly, even on a quarterly basis, for the sole purpose of assessing the performance of the business, clients tend to be more engaged, execute strategies more consistently, and frankly, make a heck of a lot more money!  In the final analysis, we are helping them keep themselves accountable by orchestrating  the reading of the scorecard.

At this time of year when we “resolve”  to improve, it’s a great time to develop tools to measure business performance and get very intentional about the way we run our companies!  How’s this for a New Year’s resolution…call your accountant and ask him or her how they can help you better measure your performance.  You might be amazed at the untapped resource on your team!

Fiscal Cliff Deal

Just as I predicted, taxes are going up.  While we were bringing in the New Year with our loved ones (or sleeping if you have little kids like me), the Senate agreed on a deal and the House passed it as well.  You may or may not know the details of the “fiscal cliff” deal by now.  Since it’s the New Year and I’d like to start it out on a positive note. I’ll try to approach the deal with the most optimistic tone as possible (though there is quite a bit to be pessimistic about in this deal). 

One thing I was glad to see was the permanent AMT patch.  Past legislation has only applied temporary patches to the AMT mess and made tax planning very difficult (2012 was no exception).  They finally made the “patch” permanent and indexed for inflation each year.  AMT still needs a serious overhaul, but this will help us in the mean time and saved over 60 million Americans from being subject to AMT (myself included!).  While I’m happy this patch is permanent, I’m concerned it means Congress won’t be as eager to redo or eliminate the AMT issue since it’s no longer urgent. 

Part of my prediction was correct on the income tax rates; rates for lower and middle income taxpayers were extended, however they were set permanently which I wasn’t expecting.  While I’m happy with the permanent nature because it helps with tax planning, it doesn’t mean Congress won’t change it again. The debt ceiling issue is again quickly approaching and tax rates may be thrown into the negotiations once again.  The other “positive” in the tax rates was the apparent compromise on the top tax rate level.  The President was proposing the 39.6% tax rate to be effective for income (based on adjusted gross income (AGI)) over $200,000/$250,000 (single/married).  The compromise ended up setting the 39.6% rate on taxable income (after deductions) of $400,000/$450,000 (single/married).  I see two positives in there.  While I disagree whole-heartedly with increasing taxes on the wealthy (a.k.a. usually the job creators), it’s a compromise that seemed inevitable and ended up better than I expected. 

While the income tax rates for the lower and middle income taxpayers are not going up, the payroll taxes did increase.  The 2% payroll tax holiday we’ve been enjoying was allowed to expire.  If you make $50,000 a year, you will bring home $1,000 less this year. 

The “wealthy” Americans will also be subject to the following tax increases (not inclusive):

  • Capital gains/ Dividend tax rates: from 15% to 23.8 %
  • Personal exemption phase out (previously eliminated), starts at $300,000 for married couples   ($250,000 single)
  • Limitation on itemized deductions (previously eliminated), starts at $300,000 for married couples ($250,000 single)
  • Estate taxes permanently increased from 35% to 40%, although they did set the exclusion at $5million (adjusted for inflation) which was set to expire back to $1million at 55% 1/1/13. 

The following items were set to expire, but have been extended (not inclusive):

  • Child tax credit of $1,000 was made permanent
  • Earned income credit was extended through 2017
  • Adoption credit/assistance was made permanent at $10,000
  • Child and dependent care credit was made permanent
  • Employer-provided child care credit was made permanent
  • American opportunity tax credit (higher education) was extended through 2017
  • Above-the-line deduction for qualifying tuition and expenses extended through 2013
  • Teachers’ classroom expense deduction extended through 2013
  • Exclusion of cancellation of indebtedness on principal residence extended through 2013 

Business related items in the deal include (not inclusive):

  • Section 179 deduction of $500,000 with a $2million investment limit for 2012 and 2013
  • Extended 50% bonus depreciation through 2013
  • Research tax credit was extended through 2013
  • Work Opportunity Tax Credit was extended through 2013
  • 100% exclusion for gain on sale of qualified small business (Sec. 1202) stock (see Paul Polito’s website article here)
  • A number of green energy tax incentives 

Not the perfect deal, but at least one was made.  We were saved from the “fiscal cliff” and now maybe we don’t have hear that term again… for the time being. 

Happy New Year everyone!

 

Deductible Auto Mileage Expense Increase

The IRS has issued the new mileage rates.  Beginning January 1, 2013, the standard mileage rate for business purpose is 56.5 cents per mile (a 1 cent increase).  The most common uses of the rate include:

  • Mileage reimbursement to employees using an accountable reimbursement plan (can be less than the federal rates, but never greater)
  • Mileage deducted on schedule C
  • Unreimbursed business miles deducted on Schedule A

The IRS publishes these rates as a guideline, not a requirement.  Businesses are allowed to use a lower rate if they choose.  However, you cannot use a higher rate.  If a business reimburses its employees using a higher rate, the difference would be taxable to the employee.

The mileage rates for medical or moving expenses also increased to 24 cents per mile.  The charitable mileage rate remains at 14 cents per mile.

Is a Roth IRA Conversion Right for You?

We’ve been discussing ideas to accelerate income and pay taxes with 2012 tax rates rather than with the anticipated future increased tax rates.  Converting a traditional IRA to a Roth IRA has been a hot topic for the last few years, and continues to be in the current conditions.  This is a complicated decision and should include discussions with both your tax advisor and financial advisor.

In the past, it was almost always a recommendation for younger tax payers to make the conversion in years with large ordinary losses.  When you make a conversion, you have to pick up the entire amount as income and pay tax.  If you could pick up the income in a year with large losses, you might have accomplished the conversion with little or no tax cost.  If you anticipate ordinary losses in 2012, this is still a strategy to consider. Capital losses don’t count!

It’s also a strategy to consider for taxpayers in the higher brackets even if you don’t have losses to offset the income.  Depending on your financial forecast, it may be beneficial for you to pick up the income this year with low 2012 tax rates and have tax free distributions later in life, rather than have taxable distributions in the future at potentially higher tax rates.

There is speculation that Congress might close this “loophole” soon.  There is no other tax advantage like this where you can grow money tax free.  Therefore, if you’ve been considering a conversion or starting a Roth IRA from scratch, I strongly suggest you do it now and put as much money into it as possible. Generally limitations on Roth IRA contributions are the same as traditional IRA contributions.

Tax planning involves a lot of hypothetical considerations and future predictions.  Tax planning is about paying as little tax as legally possible over your entire life, not just year to year.  This year in particular is a good example.  We are taking a close look at our clients and asking, should we pay more tax this year to save in future years?  Not all taxpayers have the cash flow to consider these options, but if you do, this is the year to think about it.

As always, seek advice from your tax advisor when considering your planning strategies.

 

 

Blog facts correction: Capital Gains Harvesting

The tax harvesting blog had an error that we’d like to correct.  The concept is still important to consider.  However we were comparing short term capital gain tax rates to long term capital gain tax rates.  

Long term capital gains tax rate is currently maxed at 15%.  It will go back to 20% in 2013 and is subject to the 3.8% investment surtax for higher income individuals (for a total of 23.8%).  

Short term capital gains are taxed at your ordinary income rate which is current maxed at 35%.  It will jump up to 39.6% if Congress doesn’t act.  When you ad the 3.8% investment surtax for higher income individuals, the total is 43.4%. 

Historically capital gains harvesting has been a strategy to use up large capital losses.  This year, it’s a strategy to pay federal capital gains tax at a lower rate (15%) rather than pay tax at the projected rate of 23.8%. If you sell the asset, thus harvesting the capital gain, you can turn around and purchase the asset again.  Now you have a higher basis so that when you sell it in the future, you are paying less tax. 

Here is the simplified example: 

Stock X purchased 1/1/2005  $      5,000 Stock X purchased 1/1/2008  $          5,000
Value on 11/30/12  $    75,000    
Projected value on 12/31/14  $  105,000 Projected value on 12/31/14  $     105,000
       
If sold on 11/30/12 and then repurchased:    
2012 capital gain  $    70,000    
Tax on capital gain  $    10,500    
New Stock X basis  $    75,000    
       
Then sold again on 12/31/14   Sold  on 12/31/14  
2014 capital gain  $    30,000 2014 capital gain  $     100,000
Projected tax on gain  $      7,140 Projected tax on gain  $       23,800
       
Total tax paid on investment  $    17,640 Total tax paid on investment  $       23,800
Total gain after taxes  $    82,360 Total gain after taxes  $       71,200

 Tax saved from harvesting capital gains is $11,160. 

This strategy is easily executed with publicly traded stock.  It’s a bit trickier with other assets.  However, if you have been trying to sell a capital asset with a large gain, it might be worth sitting down with your accountant to find out if the tax savings justify lowering the price to affect a sale in 2012. 

We used an extremely simplified example to help illustrate the concept.  However, investments are usually much more complicated.  As always, see your tax advisor for help in applying tax planning strategies to your tax plan. 

We apologize for the error.

All $250,000 taxpayers may be the Wrong Target…Too important for such a broad brush.

All $250,000 taxpayers will often be the wrong target if the goal is to rebuild the economy with private sector jobs.

I have served small and medium sized private companies for over 35 years. The proposed tax increase on those so called “wealthiest Americans” is one of those broad brush solutions that will turn out to be counter-productive.

We know that employment is driven primarily by small to medium size privately held companies.  This makes sense.  These are usually owned by someone who lives in the U.S., works in the U.S. and does business primarily in the U.S.  Simply put, most small businesses exist to create a job for their owners and employees.  Contrast this “business purpose” with the purpose of a public company.  Public companies strive to build shareholder value.  Ever increasing pressure to create earnings tends to push labor intensive processes overseas and eliminate jobs through automation.

A study of most business classes will indicate that profit margin (net profit) generally runs between 5% and 10% if the business is profitable.  This category called “small to medium” size will have revenues somewhere between $2 million and $200 million.

Most of these businesses report their income and pay their taxes on the owner’s tax return.  Most of these business owners will tend to take salaries in the low 6 figures….say between $100,000 and $300,000.  Now let’s say that a typical “expanding” business grosses $5 million and nets 5%.  That net is $250,000.  When you add that to the say, $200,000 in salary, you are right in the cross hairs of the president’s proposed tax increase.  What may not be understood is that the $250,000 in profit is not in the owner’s hands.  It is in the business.  These earnings pay for things like new equipment, additional employees, debt principal and owner draws for taxes which are not deductible. 

In the accounting business, we call the $250,000 in my example “pass through” income.  The taxable income is passed to the shareholder’s or partner’s tax return, but the cash generally, is not.  When you tax it, the money has to come out of the company’s working capital leaving fewer dollars for expansion, hiring new employees, etc.

Also, when this “pass through” income is added to the owner’s salary, it is taxed at the owner’s highest rate which will be higher than the corporate rate if the President’s proposal is accepted by Congress.  It should not be taxed at a higher rate than the large corporations pay.  To do so will further cripple our economy.

An Individual who makes $200,000 per year in salary or a couple that makes $250,000 without adding any jobs to the economy probably ought to pay more tax.  But a business that employs people should not be subject to the same level of tax.  Fairness is not at issue here.  Our struggling economy is the issue!  There should probably be some sort of exemption or maximum rate of tax (like the current treatment of capital gains) for business pass through income that will help stimulate job growth in the economy.

Tax Planning Strategy: Capital Gains Harvesting

This post is currently being updated for corrections, watch for the re-post.

My prediction: Taxes are going up

President Barack Obama was reelected president and Democrats maintain control of the Senate.  Republicans still have majority in the House.  While this may mean that nothing as significant as the Affordable Care Act will pass again (at least within the next two years), it also means a complete repeal is unlikely.  All those tax increases start next year in 2013.  In addition, Californians just passed a new tax primarily aimed at the “wealthy”.  The President wants to tap the wealthy too!  Here’s a run down of what’s in store, just to name a few new taxes: 

-         California Prop 30 increases CA taxes on earnings over $250,000 for single taxpayers ($500,000 joint filers) retroactively beginning January 1, 2012, and increases sales tax by 0.25% beginning 2013

-         “Bush-era” tax cuts expire end of 2012 bringing tax rates up across the board, restoring the “Marriage Penalty”, and increasing tax rates on capital gains and dividends

-         The “Affordable Care Act”  imposes a new Medicare tax on investment income and the “wealthy” commencing 2013

-         Estate taxes increase and the gift exclusion decreases by over $4 million!

-         Payroll tax holiday (we’ve been paying 2% less in social security taxes) expires after 2012 

If I had to guess at what the future holds, I think Congress will pass the President’s proposal which extends the Bush tax cuts for lower to middle income families but increases taxes on the upper income levels. 

Here is a table that may help show the federal increases visually:

 

2012 rates

Affordable Care Act increases

Expired cuts increased rates by

2013 rates

President’s Proposal

Individual tax rates (income ranges for MFJ as of 2012)

 (2)

      $0 – $17,400

10%

 5%

15%

10%

      $17,400 – $70,700

15%

15%

15%

   $70,701 – $142,700

25%

 3%

28%

25%

  $142,701 – $217,450

28%

 3%

31%

28%

  $217,451 – $388,350

33%

 3%

36%

33%

      $388,350 +

35%

 4.6%

39.6%

36%

 

39.6%

 
Capital gains

15%

3.80% (1)

5%

23.80%

23.8%

Dividends

15%

3.80% (1)

25%

43.40%

43.4%

Medicare tax – high wage earners

1.45%

0.90% (1)

2.35%

2.35%

Estate tax

35%

20%

55%

Lifetime gift exclusion

           5,120,000

         1,000,000

 (1)   Individuals will pay an additional 0.9% Medicare Hospital Insurance (HI) tax on wages and self-employment income on amounts earned above certain threshold amounts: 1. $250,000 for joint returns; 2. $125,000 for married filing separate; and $200,000 for all others. To the extent that the amount of the income exceed the threshold, the tax on investment income is 3.8% of the lesser of:

1.      Net investment income, or

2.      The excess of modified adjusted gross income (MAGI) over a threshold amount. 

(2)   Income ranges differ from 2012 income ranges 

Here is a table that shows the CA Prop 30 increases (taxable income ranges): 

Prop 30 (effective January 1, 2012)

$250,001 -$300,000 for single/MFS

10.3% (1% increase)

$340,001 – $408,000 for HOH
$500,001 – $600,000 for MFJ
$300,001 -$500,000 for single/MFS

11.3% (2% increase)

$408,001 – $680,000 for HOH
$600,001 – $1,000,000 for MFJ
More than $500,000 for single/MFS

12.3% (3% increase)

More than $680,000 for HOH
More than $1,000,000 for MFJ

 

 

Unusual Year for Tax Planning

Today is the day.  It’s VOTING day and likely one to go down in history as a game changer.  We have two very different options and two very different paths for our future.  I find it interesting how much social media has contributed to this election.  Almost everyone is talking about it and I feel it has increased the conversation that was lacking in prior years.  My generation (20-35 year olds) needs to step up, and I feel social media has helped start it.  When you see people talking about politics, it encourages you to pay attention and maybe even do some research.  I personally have done more research this year than all my prior voting years combined, and I for one think it’s a good thing.

 

Why am I talking about the elections? Because depending on who wins tonight (both president and congress) decides how we start guessing what the future holds… as far as taxes, that is.  Everyone agrees, our combined tax rates are at the lowest levels in recent history (some of you may remember the days when the top federal tax rate was 91%!).  It’s very likely that tax rates will increase, especially for the “wealthy”.  Usually tax planning involves finding ways to reduce the tax liability by deferring income and accelerating deductions.  It may not be the right choice this year.  Believe it or not, it may be a year to INCREASE the tax liability!  You read it right!  Pay more taxes.  Why?  Because you may be in a higher tax bracket next year and in future years.  This isn’t the right strategy for everyone.  Tax planning is complicated and should always involve your tax advisor.  We will start discussing possible strategies in the weeks to come that may be helpful to you when developing a tax plan with your tax advisor.

Don’t forget to vote!

Whistleblower gets a Payday

According to the National Whistleblowers Center, the Internal Revenue Service (IRS) has awarded former UBS banker Bradley Birkenfeld a whistleblower reward of $104 million which is believed to be the largest reward ever given to an individual whistleblower in the US.

The IRS is authorized to pay rewards from 15% to 30% of the collected proceeds if information provided by a whistleblower substantially contributes to the detection and recovery of taxes, penalties and interest. While the IRS was aware of the compliance issues and the illegal offshore banking scheme, it was Mr. Birkenfeld’s disclosures that “formed the basis for unprecedented actions against UBS” and resulted in a fine paid to the US by UBS bank for $780,000,000 (that’s a lot of zeros!). The IRS also launched the amnesty program for taxpayers to voluntarily disclose their offshore accounts which resulted in 35,000 taxpayers participating and paying over $5 billion in back taxes, fines and penalties.

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