Tax planning introduction fall 2012

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  • The roots of IRS go back to the Civil War when President Lincoln and Congress, in 1862, created the position of commissioner of Internal Revenue and enacted an income tax to pay war expenses. The income tax was repealed 10 years later. Congress revived the income tax in 1894, but the Supreme Court ruled it unconstitutional the following year. 16th Amendment In 1913, Wyoming ratified the 16th Amendment, providing the three-quarter majority of states necessary to amend the Constitution. The 16th Amendment gave Congress the authority to enact an income tax. That same year, the first Form 1040 appeared after Congress levied a 1 percent tax on net personal incomes above $3,000 with a 6 percent surtax on incomes of more than $500,000. In 1918, during World War I, the top rate of the income tax rose to 77 percent to help finance the war effort. It dropped sharply in the post-war years, down to 24 percent in 1929, and rose again during the Depression. During World War II, Congress introduced payroll withholding and quarterly tax payments.
  • This was the first return in 1913
  • IMPACT. The extension significantly benefits taxpayers in the top two income brackets who, without the extension, would have seen top rates of 36 and 39.6 percent, respectively, after 2010. However, the extension is temporary for all taxpayers. A 15, 28, 31, 36 and 39.6 rate structure will start after 2012 without further Congressional action. Also looming after 2012, higher income taxpayers will be hit with an additional 0.9 percent Medicare tax and a 3.8 percent Medicare contribution tax (both discussed in connection with recent health care legislation, below). IMPACT. Higher-income taxpayers also benefit immediately from a two-year extension of the elimination of the limitation on itemized deductions and the personal exemption phase-out Alternative Minimum Tax Passage of the 2010 Tax Relief Act also prevents the AMT from encroaching on middle income taxpayers. The legislation creates an AMT “patch” for 2010 and 2011. Congress increased the exemption amounts for 2010to $47,450 for single individuals, $72,450for married couples and surviving spouses,and $36,225 for married individuals filing a separate return. The exemption amounts for 2011 are $48,450 for single individuals,$74,450 for married couples and surviving spouses, and $37,225 for married individuals filing a separate return. Payroll Tax Cut The 2010 Tax Relief Act reduces the employee-share of OASDI tax from 6.2 percent to 4.2 percent for wages paid in calendar year 2011 up to the taxable maximum of $106,800. The one-year payroll tax cut replaces the Making Work Pay credit, which is scheduled to expire after 2010.
  • It seems that every year there is a new tax law or change in existing law. These are just a few of the more recent changes. We will go over each of these changes during the course, but here is a quick overview of the recent changes.
  • Certain government retirees can claim a refundable $250 tax credit for their first tax year beginning in 2009. The credit is $500 on a joint return if both spouses are eligible. To be eligible for the credit, you must meet all the following tests:(1) During your first tax year beginning in 2009,you must receive some amount as a pension or annuity for service performed in the employ of the United States, any state, or any instrumentality thereof, that is not considered employment for Federal Insurance Contributions Act (social security tax) purposes.(2) You must not receive an economic recovery payment during the tax year. (3) Your tax return must include your social security number. A joint return must include the social security number of at least one of the spouses. Low and moderate-income taxpayers may be eligible for the earned income tax credit (EITC), depending on their income, filing status, and immigration and work status. If you are eligible, the amount you receive depends on the number of children in your family, how much income you earn, and the amount of your adjusted gross income. If you are eligible for the EITC, you may be entitled to a larger credit for tax years 2009 and 2010.For taxpayers with three or more eligible children, the credit percentage used to calculate the EITC is increased to 45 percent (instead of 40 percent). For married taxpayers, the phase-out amount is increased to $5,000 more than the amount used for other taxpayers (instead of $3,000 more), adjusted for inflation for 2010. Thus, for tax years beginning in2009,
  • The law increases the monthly multiplier from $85 to $89 for the Code Sec. 6699(b)(1) failure-to-file penalty applicable to S corporation income tax returns. This provision applies to returns filed after December 31, 2008, and it is expected to raise an additional $38 million in revenue over the next 10 years. Partnership penalties-The law increases the monthly multiplier from $85 to $89 for the Code Sec. 6698(b)(1) failure-to-file penalty applicable to partnership returns. This provision applies to returns filed after December 31, 2008, and it is expected to raise an additional $42 million in revenue over the next 10 years.
  • Congress included an alternative minimum tax (AMT) patch in the new law. Under the new law’s patch for the 2008 tax year, the AMT exemption amounts are $69,950 for married couples filing jointly and surviving spouses, $46,200 for single taxpayers and heads of household, and $34,975 for married couples filing separately for 2008. The rescue plan extends a temporary rule for cancellation of indebtedness income. When a lender forecloses on property, sells the home for less than the borrower’s outstanding mortgage and forgives all or part of the excess mortgage debt, the tax code treats the cancelled debt as taxable income to the homeowner. The Mortgage Forgiveness Debt Relief Act, enacted in late 2007, excludes from federal tax those discharges involving up to $2 million of indebtedness ($1 million for a married taxpayer filing a separate return) secured by principal residence and incurred in the acquisition, construction or substantial improvement of the residence. The new law extends this treatment from the end of 2009 through 2012 The new law extends through December31, 2009, the above-the-line higher education tuition deduction. The deduction allows eligible taxpayers to deduct the costs of qualified higher education expenses paid during the year for themselves, a spouse, or a dependent. The new law permits taxpayers to make tax-free distributions from IRAs for charitable purposes through December 31,2009. This popular charitable contribution option had expired January 1, 2008. The maximum contribution limit for 2008 and again for 2009 is $100,000. Impact. This treatment applies to traditional and Roth IRAs. However, no charitable deduction is allowed for any portion of these withdrawals that would have been otherwise taxable.
  • The new law allows a refundable credit against tax (the “recovery rebate credit") to low and middle-income individuals for 2008 in an amount calculated as the greater of:(1) Net income tax liability, not to exceed$600 ($1,200 for joint filers), or(2) $300 ($600 for joint filers) if the individual has either: (a) At least $3,000 of any combination of earned income, Social Security benefits and certain veterans’ benefits (including survivors of disabled veterans), or (b) Net income tax liability of at least$1 and gross income greater than the sum of the applicable basic standard deduction amount and personal exemptions) ($8,950 for singles, $17,900 for joint filers).
  • The bill, The Pension Protection Act of 2006, H.R. 4, tightens the rules governing how companies fund their pension plans and is designed to keep taxpayers from bailing out of the nation's pension insurer. Under the legislation, companies would have to fully fund their pension plans within seven years. Companies with pension shortfalls would have to move more quickly. Airlines in bankruptcy proceedings that have frozen their pension plans have an extra 10 years to meet their funding obligations Other tax measures that became law include: Allowing families to make tax-free withdrawals from their state-sponsored college savings plans for college expenses. This measure is permanent. Increased flexibility and favorable tax treatment to allow individuals with annuity and life insurance contracts with a long-term care insurance option to use the cash value of their annuities to pay for long-term care insurance. The ability to roll over after-tax amounts in 403(b) annuity contracts to a qualified plan, effective for tax years beginning after 2006. Allowing direct rollovers from retirement plans to Roth IRAs. Individuals with an AGI of less than $100,000 may roll over money from a traditional IRA to a Roth IRA. Penalty-free withdrawals from retirement plans for individuals called to active duty for at least 179 days. The Code section 72(t) 10 percent premature distribution tax applies to distributions from plans and IRAs before age 59-1/2, subject to specified exceptions. A waiver of the 10 percent early withdrawal penalty tax on certain distributions of pension plans for public safety employees. Generally, there is a 10 percent premature distribution tax for distributions before age 59-1/2. There are several exceptions, including distributions on separation after age 55. The proposal allows public safety officers to avoid the early distribution penalty for distributions based on separation from service if the officer is at least 50 (rather than 55). The proposal is effective for distributions after August 17, 2006. Allowing rollovers by non-spouse beneficiaries of certain retirement plan distributions. Generally, participants and surviving spouses may roll over amounts from qualified plans, 403(b) annuities, and IRAs to another plan or IRA. Non-spouse beneficiaries may not roll over inherited amounts.
  • This is the law and must be followed by all parties, the IRS, the Courts and by taxpayers.
  • The regulations are interpretations of the Internal Revenue Code by the Commissioner of the Internal Revenue Service.
  • Revenue Rulings take a particular set of facts and apply the Commissioner’s interpretation to them. For example, Revenue Ruling 2007-69 asked whether payments made by the U.S. Department of Veterans Affairs (VA) under the compensated work therapy program are exempt from federal income tax as veterans' benefits. The ruling will go through the facts and the law and render a conclusion. In this ruling it was determined that the amounts were exempt from federal income tax. Most IRS employees have to strictly follow Revenue Rulings and Revenue Procedures.
  • Tax planning is a complex subject. It does not mean that the average person cannot understand the fundamental concepts. However the tax code has been getting more difficult to master. This is for two reasons. First, it is becoming more complex with layer upon layer of rules, exceptions to the rules and exceptions to those exceptions. Second, many of the major and more recent provisions of the code have change built in, through phased-in, phased-out, temporary and delayed effective dates.
  • Accordingly, an understanding of the basic concepts of the income tax law is essential. In this course there are some issues that will have substantial focus. Federal Tax Structure Issues relating to income and expenses Acquisition and disposition rules
  • When you prepare your tax return two to three months after the close of the tax year, it is generally too late to do anything except file the return on the basis of what took place in the preceding year. There are some exceptions, for example, many individuals can make post-year-end IRA or Keogh plan contributions and reduce their taxes for the prior year. The basic strategy for tax planning is to time your income so that it will be taxed at a lower rate and to time your deductible expenses so that they may be claimed in years when you are in a higher tax bracket. This usually means that if you expect to be in a lower tax bracket in 2009 compared to 2008, you should defer the receipt of income to 2009 and accelerate your deductions into 2008. Conversely, if you expect to be in a higher tax bracket in 2009, you should accelerate your income into 2008 and defer your deductions until 2009
  • Tax planning introduction fall 2012

    1. 1. INCOME TAX FINANCIAL PLANNING Instructor: Dennis Phillips
    2. 2. CLASS SCHEDULE <ul><li>Class is from 6:00 to 10:00 p.m.. I will shorten up breaks so that we can usually leave a little early. </li></ul>
    3. 3. GRADING FOR COURSE <ul><li>20% for attendance (Can be made up with doing odd number problems in Group 1 and even number problems in Group 2) </li></ul><ul><li>30% for turning in problems </li></ul><ul><li>20% for the mid-term </li></ul><ul><li>30% for final exam. </li></ul>
    4. 4. ATTENDANCE SHEET <ul><li>Each night I will provide you with an attendance sheet which must be signed. </li></ul><ul><li>If you cannot make the class, to make up the absence, you must complete all the problems in group 1 and 2. (Both odd and even problems in both groups) </li></ul>
    5. 5. HISTORY OF INCOME TAX <ul><li>Modern Federal income tax began with the enactment of the Revenue Act of 1913. Between 1913 and 1939, 15 revenue acts were passed by Congress. Whenever it was necessary to change the law, a new law was substituted for the old, with much of the new law taken from the old. </li></ul>
    6. 7. HISTORY OF INCOME TAX <ul><li>Congress adopted the Internal Revenue Code of 1939, to which provisions could be added or deleted by Congressional Amendment. </li></ul><ul><li>Between 1939 and 1953 the IRC of 1939 was amended 21 times. To establish a more logical arrangement and eliminate some inequities, the IRC of 1954 was adopted. This code was amended so many times that the 1986 Code was adopted after implementation of the TRA of 1986. </li></ul>
    7. 8. TAX LAW CHANGES <ul><li>On December 17, 2010, President Obama </li></ul><ul><li>signed into law a two-year extension of the </li></ul><ul><li>reduced individual income tax rates put in </li></ul><ul><li>place by the Economic Growth and Tax Relief </li></ul><ul><li>Reconciliation Act of 2001 (EGTRRA) </li></ul><ul><li>and subsequent legislation. Under the 2010 </li></ul><ul><li>Tax Relief Act, the individual rates remain </li></ul><ul><li>at 10, 15, 25, 28, 33, and 35 percent for all </li></ul><ul><li>taxpayers through the end of 2012. </li></ul>
    8. 9. TAX LAW CHANGES <ul><li>American Recovery & Reinvestment Act of 2009 </li></ul><ul><li>Worker, Retiree, and Employer Recovery Act of 2008 </li></ul><ul><li>Emergency Economic Stabilization Act of 2008 </li></ul><ul><li>Housing Assistance Tax Act of 2008 </li></ul><ul><li>Economic Stimulus Act of 2008 </li></ul><ul><li>Small Business & job Opportunity Act of 2007 </li></ul><ul><li>The Pension Protection Act of 2006 </li></ul>
    9. 10. American Recovery & Reinvestment Act of 2009 <ul><li>a one-time stimulus payment of $250 to retirees, disabled individuals, social security recipients, and disabled veterans </li></ul><ul><li>a temporary increase of the earned income </li></ul><ul><li>credit for working families with three or more children; </li></ul>
    10. 11. American Recovery & Reinvestment Act of 2009 <ul><li>a deduction for state and local taxes paid on the purchase of a new automobile during 2009 </li></ul><ul><li>a suspension of federal income tax on the </li></ul><ul><li>first $2,400 of unemployment benefits per recipient for 2009. </li></ul>
    11. 12. WORKER, RETIREE, AND EMPLOYER RECOVERY ACT OF 2008 <ul><li>Suspension of RMD for 2009 </li></ul><ul><li>Increased S Corp penalties </li></ul><ul><li>Increased Partnership Penalties </li></ul>
    12. 13. EMERGENCY ECONOMIC STABILIZATION ACT OF 2008 <ul><li>AMT PATCH </li></ul><ul><li>Extended Exclusion for Homeowners </li></ul><ul><li>Higher Education Tuition Deduction </li></ul><ul><li>Tax-Free Distributions from IRAs for Charitable Purposes </li></ul>
    13. 14. STIMULUS ACT OF 2008 <ul><li>Provides Tax Benefits to Businesses </li></ul><ul><li>Provides Rebates to individuals </li></ul>
    14. 15. The Pension Protection Act of 2006 <ul><li>Makes permanent the higher contribution limit for individual retirement accounts (IRAs) </li></ul><ul><li>Allows direct rollovers from retirement plans to Roth IRAs </li></ul>
    15. 16. LEGISLATIVE PROCESS <ul><li>All Federal income tax legislation originates in the House of Representatives. Hearing are held by the Committee on Ways and Means. Many viewpoints are considered including those of the President, the Treasury, and individual taxpayers. </li></ul>
    16. 17. LEGISLATIVE PROCESS <ul><li>When a bill is introduced in the house, the committee report on that bill is published. </li></ul><ul><li>When a bill is considered by the Senate, the Senate Finance Committee holds hearings, and also writes a report explaining any changes made to the House bill. </li></ul><ul><li>If the House and Senate passed bills differ, a Conference Committee of both Representatives and Senators is formed to reconcile the difference. </li></ul>
    17. 18. LEGISLATIVE PROCESS <ul><li>This committee issues a Conference report. </li></ul><ul><li>The reconciled bill is then resubmitted to both the House and Senate for passage. </li></ul>
    18. 19. SOURCES OF INFORMATION <ul><li>INTERNAL REVENUE CODE </li></ul><ul><li>TREASURY REGULATIONS </li></ul><ul><li>REVENUE RULINGS AND REVENUE PROCEDURES </li></ul><ul><li>PRIVATE LETTER RULINGS </li></ul><ul><li>JUDICIAL SOURCES OF THE TAX LAW </li></ul>
    19. 20. INTERNAL REVENUE CODE <ul><li>The code is compiled and published in the United States Code (U.S.C.) under Title 26. </li></ul>
    20. 21. TREASURY REGULATIONS <ul><li>Section 7805 of the IRC grants authority for the commissioner of the IRS to prescribe rules and regulations for the enforcement of the IRC. </li></ul><ul><li>The regulations interpret the Code. They are arranged in the same sequence. Regulations are, however, prefixed by a number which designates the type of tax or administrative, procedural or definitional matter to which they relate. </li></ul>
    21. 22. REVENUE RULINGS AND REVENUE PROCEDURES <ul><li>Revenue Rulings provide interpretation of the tax law. They do not, however, have the same legal weight as do the regulations and usually deal with more restricted problems. </li></ul><ul><li>Revenue Procedures deal with internal management practices and procedures of the IRS. </li></ul>
    22. 23. PRIVATE LETTER RULINGS <ul><li>Letter rulings are issued upon a taxpayer's request and describe how the IRS will treat a proposed transaction for tax purposes. </li></ul><ul><li>The IRS limits the issuance of individual letter rulings to restricted, preannounced areas of taxation. </li></ul><ul><li>The IRS will not rule in areas when they involve fact oriented situations. </li></ul>
    23. 24. JUDICIAL SOURCES OF THE TAX LAW <ul><li>Cases involving Federal tax litigation may be brought in either the U.S. Tax Court, Federal District Court or Claims Court. </li></ul><ul><li>However, in order to petition the Federal District Court or the Claims Court, the taxpayer must first pay the tax and file a claim for refund. Such refund would have to be denied by the IRS and a statutory notice of claim disallowance issued. </li></ul>
    24. 25. TAX PLANNING <ul><li>Complexity of the tax code </li></ul>
    25. 26. TAX PLANNING <ul><li>Taxes represent an additional cost of doing business or of accumulating wealth. </li></ul><ul><li>Tax Planning is the process of arranging one’s financial affairs to optimize tax liabilities. There is nothing illegal or immoral in the avoidance of taxation. </li></ul>
    26. 27. TAX PLANNING <ul><li>Tax evasion is illegal </li></ul><ul><li>Ever since the first enactment of the first income tax laws, taxpayers have been trying to find ways to avoid taxes. Likewise, Congress, the IRS and the courts have enacted rules and doctrines to prevent, or least restrict various avoidance schemes. </li></ul>
    27. 28. TAX PLANNING <ul><li>A basic knowledge of the tax system is necessary for any tax planner if disasters are to be avoided </li></ul>
    28. 29. TAX PLANNING <ul><li>Any investor must consider income tax as a part of the cost of any investment. </li></ul><ul><li>A financial planner must attempt to minimize the tax element of the investment cost. </li></ul>
    29. 30. TAX PLANNING <ul><li>Window of opportunity generally ends on December 31 for most individual taxpayers. </li></ul><ul><li>Tax planning primarily concerns the timing and method of income reporting and your deductions and credits are claimed. </li></ul>

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