February 1, 2010

During 2009 the President signed into law several Congressional Acts containing amendments to the Internal Revenue Code which could affect your tax liability for 2009.  Just as important as we go forward into 2010 is the unfinished tax business of 2009 both at the Federal and State level which no doubt will be addressed in 2010. 

We look forward to discussing with you in more detail any of the following that affect your particular situation. 

FINISHED BUSINESS

1.       IRS WARNING: SPAM: Throughout 2009 and continuing as late as January 4, 2010, the IRS has been issuing consumer warnings advising taxpayers about the fraudulent use of the IRS name in Phishing and Spam scams.  The basic rule is: 

2.     Retroactive Changes:  Haiti: 

On the evening of January 22, 2010 the President signed the Haiti Assistance Income Tax Incentive Act that permits taxpayers to make contributions between January 12, 2010 and February 28, 2010 for Haitian relief and deduct those contributions on their 2009 tax return.  Moreover, the only documentation needed to vouch the deduction is a telephone bill if it shows the name of the donee organization, the date of the contribution, and the amount of the contribution.

3.     2010 Opportunity to Convert to Roth IRA.

2010 is the first year in which taxpayers may convert funds in traditional IRAs (as well as qualified retirement plan funds) to Roth IRAs regardless of their income level. A Roth IRA is a nondeductible IRA that allows income to accrue tax free.  Unlike traditional IRAs, Roth IRAs are not subject to taxation on distribution if certain age and timing requirements are met.  Conversions to a Roth IRA are subject to tax in the year of conversion.  In spite of the upfront tax liability, conversion may be desirable because distributions from Roth IRAs will be tax-free if the age and timing conditions are met.  Moreover, a Roth IRA owner does not have to commence lifetime required minimum distributions (RMDs) from Roth IRAs after he or she reaches age 70 1/2. Accordingly, if you do not need to withdraw funds from your IRA for living expenses, a Roth IRA allows you to accumulate tax free income for your beneficiaries.  Roth IRAs are popular now because account values are low and a special rule allows you to elect to defer the tax due on your conversion to 2011 and 2012.  By converting, you would be paying tax now for the future privilege of tax-free withdrawals, and freedom from the RMD rules. The conversion is not for everyone and if your account value drops you could end up paying tax on income you never receive.  However, it does have a reconversion option to mitigate your risk of declining account values for the next year.  Conversions are subject to several technical rules and strict time limits.  We can discuss with you whether a conversion is appropriate for your situation.

4.     First Time Home Buyer Credit (FTHTC) for first time home buyers

The FTHTC has been extended to apply to a principal residence purchased by a first time home buyer before May 1, 2010 and to the purchase of a principal residence before July 1, 2010 by a first time home buyer who enters into a written binding contract before May 1, 2010, to close on the purchase of a principal residence before July 1, 2010. There is an extended period available to qualifying service members.

For purchases after Nov. 6, 2009 the FTHTC phases out for individual taxpayers with modified adjusted gross income between $125,000 and $145,000 ($225,000 and $245,000 for joint filers) for the year of purchase. For purchases after Nov. 6, 2009, the FTHTC cannot be claimed for buying a residence if its purchase price exceeds $800,000.  There is no phase-out mechanism. A purchase price that exceeds the $800,000 threshold by even a single dollar will cause the loss of the entire credit.

5.     First Time Home Buyer Credit (FTHTC)  for existing home owners

For purchases after Nov. 6, 2009, any individual (and, if married, the individual's spouse) who has maintained the same principal residence for any 5-consecutive year period during the 8-year period ending on the date of the purchase of a subsequent principal residence is treated for FTHTC purposes as a first-time homebuyer of that subsequent principal residence. The maximum allowable credit for such taxpayers is the lesser of: (1) $6,500 ($3,250 for a married individual filing separately); or (2) 10% of the purchase price of the subsequent principal residence.

The availability of the FTHTC for qualifying existing homeowners is especially helpful for “empty nesters” looking to sell their current homes and purchase smaller quarters.  Existing homeowners who plan to sell their residence and buy a new one have an extraordinary opportunity to get two tax breaks: They may be able to exclude part or all of their home sale gain under previously existing law which allows up to $250,000 of gain ($500,000 for qualifying joint filers) to be excluded from income; and they may qualify for a $6,500 refundable tax credit for the purchase of the replacement residence under the new rules.

For purchases after Nov. 6, 2009, the FTHTC cannot be claimed for buying a residence if its purchase price exceeds $800,000. There is no phase-out mechanism. A purchase price that exceeds the $800,000 threshold by even a single dollar will cause the loss of the entire credit.  There's no requirement for the existing principal residence to be sold in order to qualify for a FTHTC on the replacement principal residence. The prior principal residence can be retained in the hope of achieving a better selling price later on.

6.     Alternative Minimum Tax: 

To prevent millions of taxpayers falling prey to the AMT, Congress passed a one year stop gap extension of the AMT exemption.  For tax years 2009, and 2009 only, the AMT exemption amounts are increased from their 2008 level as follows:

a.         From $69,950 to $70,950 in the case of married individuals filing a joint return and surviving spouses subject to phase-out for alternative minimum incomes in excess of $150,000;

b.         From $46,200 to $46,700 for unmarried individuals other than surviving spouses subject to phase-out for alternative minimum incomes in excess of $112,500; and

c.         From $34,975 to $35,475 in the case of married individuals filing a separate return subject to phase-out for alternative minimum incomes in excess of $75,000.

The significance is that without this one year extension and without a similar extension for 2010, substantially more taxpayers would be subject to Alternative Minimum Tax.

Taxpayers are often surprised at the amount of alternative minimum tax they pay at relatively low levels of income notwithstanding the year to year increases in the exemptions.   There are two reasons for this: (i) The alternative minimum tax rate is applied from the first dollar of alternative minimum income rather than the graduated tax rates taxpayers are familiar with; and (ii) the dramatic effect of the exemption phase-out.

7.     Standard mileage rates down for 2010.

The optional mileage allowance for owned or leased autos (including vans, pickups or panel trucks) is 50¢ per mile for business travel after 2009. That's 5¢ less than the 55¢ allowance for business mileage during 2009. Further, the rate for using a car to get medical care or in connection with a move that qualifies for the moving expense deduction is 16.5¢ per mile, down 7.5¢ from the 24¢ per mile allowance for 2009.

8.     General Changes and Extensions for Business: 

a.                   Extended bonus depreciation and increased expensing;

b.                  Longer NOL carry backs for electing small businesses;

c.                   Allowing most business to carry back NOLs for 3, 4, or 5 years; and

d.                  Deferral of debt discharge income from reacquisition of certain business debt.

9.                  General Changes and Extensions for Individuals: 

a.         65% subsidy for COBRA continuation coverage on account of involuntary termination (tax-free on receipt, but recaptured by those with higher income);

b.         The refundable $400 work to pay tax credit phases out beginning at income levels of $95,000 for single and $150,000 for married joint filers.  The credit is calculated on Schedule M to Form 1040 and reposted on line 63 of Form 1040;

c.         A beefed-up higher education tax credit; and

d.         A tax deduction for state sales and excise taxes paid on up to $49,500 of the price of  new vehicles purchased after Feb. 16, 2009, and before Jan. 1, 2010.  The amount of the deduction is phased out for taxpayers whose modified adjusted gross income is between $125,000 and $135,000 for individual filers and between $250,000 and $260,000 for joint filers. 

Unfinished Business

A number of bills that seemed all but certain to pass before the end of 2009 failed to do so. However, it seems likely that action on these bills is merely postponed and that they will be enacted in 2010.

1.         Estate and gift taxes:

A significant piece of unfinished business relates to both Federal and State of Illinois estate taxes. 

a.         The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), repealed the Federal Estate Tax and the Federal Generation Skipping Tax for estates of decedents dying in 2010;

b.         The gift tax has been retained at a rate equal to the highest income tax rate (35%) for cumulative gifts in excess of $1,000,000;

c.         There are modified carryover basis rules for 2010 eliminating the step up in basis for assets in excess of $1,300,000; and

d.         The Illinois Estate Tax expired at the end of 2009 as well. 

Therefore, as this is written, there is no Federal Estate Tax and Illinois Estate Tax. 

On Dec. 3, 2009, the House of Representatives passed H.R. 4154, that would make permanent the estate, gift, and generation skipping transfer (GST) tax laws that were in effect for 2009. The Senate, however, did not take up the bill before year-end.  If no action is taken, the high levels of estate and gift taxation in existence before 2001 are slated to return for estates of decedents dying after 2010. However, most observers believe Congress will enact a “patch” of sorts that would retroactively reinstate estate and gift taxes for 2010.

2.         Extenders:

The “Tax Extenders Act of 2009,” passed the House of Representatives on Dec. 9, 2009, but was not taken up by the Senate before year end. The House bill would extend for one year 40-plus tax provisions that expired at the end of 2009, including: the research tax credit; the election to take an itemized deduction for State and local general sales taxes in lieu of the itemized deduction for State and local income taxes; the additional standard deduction for State and local real property taxes; and the above-the-line tax deduction for qualified tuition and related expenses. Most observers expect Congress to pass extender legislation in 2010.

Beyond 2010

Stock Basis Reporting:

January 1, 2011 is the date the IRS requires stock brokers to include basis information for stock acquired after this date (January 1, 2013 for options and January 1, 2012 for mutual funds) in addition to the proceeds reporting under current law.  Under the proposed IRS Regulations, the default identification method is “first in-first out”.  Therefore, during 2010, with a view toward 2011, you may want to rethink with your stock brokers when it is appropriate to opt out of “first in first out” for tax reporting purposes since doing so requires specific identification procedures.  We can discuss this further with you if you wish. 
 

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