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Monday
Dec312012

Additional Medicare Tax on High Income Earners

In the prior post I explained the NIIT and the proposed regulations. In this post I will explain the Additional Medicare Tax on earned income above the thresholds given in the chart below. This tax is in effect for tax years starting after December 31, 2012. The proposed regulations (REG-130074-11) are not in effect until after the notice and comment period has ended and final regulations have been published in the Federal Register.

The threshold amounts are nearly identical to the NIIT except Qualifying widower's threshold is $50,000 less for the additional Medicare tax.  This tax is simple, once the taxpayer's income exceeds the threshold for the taxpayer's filing status the additional income is taxed. So for a single who earns $200,001 the additional $1.00 above the $200,000 is taxed.

The rate of the tax is .9%. So on that $1 above the threshold the taxpayer pays an additional 9 cents.

This is an additional tax on the employee's earnings and is not matched by the employer. An interesting bit of addition of the regular Medicare tax rate for the employee and employer's matching plus the employee's additional Medicare tax rate as shown results in a familiar total rate.

 1.45% + 1.45% + .9% = 3.8%

 Shifting income from passive to active (earned) will not shield it from the additional tax.

Employers will be required to start withholding the additional .9% once the taxpayer's gross wages exceed $200,000 regardless of filing status. Employee requests to cease this withholding can not be honored by the employer.

If you have two jobs or have a pass through entity such as a partnership, LLC, or S corp and you anticipate the gross earnings to exceed your filing threshold you can instruct your employers to withhold additional amounts or make estimated tax payments. You will receive credit for the estimated tax payments against the Additional Medicare Tax.

This tax becomes a little more complicated for individuals who have both W-2 income and SE income and is best explained by giving the rules and using an example.

 

  1. Calculate Additional Medicare Tax on any wages exceeding the threshold without regard for to whether any taxes were withheld.
  2. Reduce the applicable threshold in 1 by the total Medicare Wages received but not below zero.
  3. Calculate Additional Medicare Tax on any SE income in excess of the reduced threshold.

Example: Married filers have wages and self-employed income totaling $300,000; husband's wage of $150,000 and wife's self-employed income of $150,000. Individual neither exceeds the $250,000 threshold for MFJ but combined they do. The husband's wages do not exceed the threshold so the couple is not liable for additional taxes on the wages. Next the $250,000 threshold is reduced by the husband's wages of $150,000 lowering the threshold to $100,000. The couple have SE Income subject to the Additional Medicare Tax of $50,000 (wife's SE Income of $150,000 - $100,000 reduced threshold).

 Both new taxes apply to NR Aliens and U.S. taxpayers living abroad. So plan accordingly.

 Remember to make to included this tax in your estimated tax payment calculations to avoid penalties and interest. Since this is a new tax many will forget to include in their estimates.

 

 

 

 

 

 

 

 

 

Wednesday
Dec262012

NII Tax - Net Investment Income Tax

To pay for Healthcare and the other goodies we will receive Congress has created two new taxes for the coming year. While the final regulations are not out the proposed regs give an idea of how the tax will be collected and from whom. Remember, these are proposed regulations and are subject to change and are not effective until finalized. Both are a Medicare Tax; one on Net Investment Income and the other on earned income exceeding $250,000 for married filing jointly (MFJ), and $200,000 if a single filer (SF).

Net Investment Income Tax' (NII) is the first new tax and will be assessed on individuals with Modified Adjusted Gross Income (MAGI) above threshold amounts given in the chart below.

These threshold amounts are not indexed for inflation! If you are exempt from Medicare Taxes you may still be subject to the NII.

Investment Income comes from the taxpayer's passive income activities that generate interest, dividends, capital gains, rents, royalties, non-qualified annuities. This is not

an all inclusive list. Other forms of non-service income could be subject to this tax. Income not subject to this tax includes wages, unemployment compensation, operating income from non-passive businesses, social security, alimony, tax exempt interest, SE income.

Also the income from a business involved in the trading of financial instruments or commodities and businesses that are passive activities for the taxpayer is subject to NIIT. If you own an interest in a partnership, LLC or S corp and are not activiley involved in the enterprise your share of the income is subject to NIIT.

Capital gains from stocks, bonds and mutual funds are subject to NIIT as are capital gain distributions from mutual funds.

NIIT will not apply to any gain on the sale of a principle residence that is excluded from gross income for regular income purposes. However, the gain from investment real estate including the gain on the sale of a second home that is not a primary residence is subject to NIIT.

Gains from the sale of interests in partnerships and S corporations to the extent the taxpayer was a passive owner are subject to NII.

The tax is assessed on the Net Investment Income after applying deductions that are properly allocable to items of gross investment income; i,e, investment interest expense, investment advisory and brokerage fees, expenses related to rental and royalty income, and state and local property taxes.

Remember the regulations are proposed, the tax will be in effect for years beginning after December 31, 2012.

If you anticipate your MAGI exceeding the threshold and that you will have table net investment income you will want to make estimated tax payments. If you have substantial investment income increase your estimated tax deposit accordingly.

 

 

Friday
Sep282012

Wash Sales... their clean. Right?

A client called late Wednesday with a question on losses resulting from stock sales. An investment made many years ago had paid off recently and the client had chosen to invest the proceeds in the stock market. Using client personnel to select the stock to purchase. Seems not all of the selections increased in value. And some selections were sold at a loss and then repurchased.

The client's basic question was could the gains be offset by the losses. My answer was in two parts. First, yes losses do offset gains. Second. Except when they are "Wash Sales". And here is where it gets technical and clients get fuzzy.

Under wash sale rules a taxpayer that sales securities and realizes a loss may not take a deduction for that loss. The "wash sale rules apply if, within a period beginning 30 days before the date of sale or disposition and ending 30 days after that date (61 day period), the taxpayer has acquired, or has entered into a contract or option to acquire substantially identical stock or securities (P 1937)(Code Sec. 1091(a):Reg.SS1.1091-1)." This rule applies to short sales of stocks or securities, and to futures contract to sell stocks or securities. This rule applies even if the stock or securities are held in an IRA. And under the "related persons rule" sells of stock by one spouse count for the other spouse in determining loss deduction under this rule.

If I were to by 1000 FaceBook shares at the market price of $42 May 18, 2012 and sold 500 shares at $28 on May 30, 2012 my deductible loss on the 500 shares would be $42-$28*500 or $7,000. On June 21 I purchase and additional 1000 shares of FaceBook stock at $32 per share. The wash sale rules apply to the May 30, 2012 stock sale and I no longer have a $7,000 deduction. I purchased subtantially identical stock (FaceBook has only one class of stock) within 30 days of the date I sold the stock. Sell date was May 30th, re-purchase date was June 21st or 22 days from the sell date. The wash sale rules apply.

When wash sale rules disallow a loss the deduction is not lost. The dissallowed loss is added to the cost of the new stock or securities increasing the buyer's basis in the new stock or securities. Thiis adjustment postpones the loss deduction until the disposition of the new investment.

My basis in the FaceBook stock is:

Purchased May 30th-500 shares at $42/share; $21,000

Purchased June 21st-1000 shares at $32/share; $32,000 plus the disallowed loss of $7,000 for a total basis of $39,000 or $39/share

This "rolling forward" of the loss continues each time a transaction meets the "Wash Rule" standard. The wash sale rule was created to prevent taxpayers from selling stock at a loss in December to be reported as a deduction and repurchasing the stock in January. It seems some taxpayers were creating a loss deductions and not really loosing anything when they repurchased the stock.

To receive the $7,000 deduction now attached to the FaceBook Stock purchased June 21st I can not purchase, contract to purchase, hold an option or futures contract on FaceBook shares until 30 days after June 21st. After July 21st I am no longer subject to the wash sale rule for the stock purchased June 21st.

This is not everything there is on wash sales, this is intended only to may the reader aware of a pitfall in frequent securities purchase and sales in the same security. As always call a CPA or investment advisor who can provide information appropriate to your situation.

Saturday
Sep222012

Penalties to the left; penalties to the right...

To the casual observer it seems there is a penalty for every infraction of IRS rules.

Yes.

There is.

The IRS wants employers and all tax payers to pay timely. And to pay using EFTPS (Electronic Federal Tax Payment System). Yes there are penalties for not making payments properly. More on making proper payments later. For amounts not deposited timely or properly the following rates apply.

2% for deposits 2-5 days late.

5% for deposits made 6-15 days late.

10% for amounts paid 16 or more days.

10% for deposits made to an unauthorized financial institution or directly to the IRS or with the return.

10% for amounts subject to electronic depositrequirements but not deposited using EFTPS.

15% for amounts unpaid 10 or more days after receiving the first notice.

 

If Tony's Tacos manager Cletus Chester failed to deposit the September 14th payroll taxes on October 15th waiting until Nov 1st would incure a penalty for Failure to Deposit (FTD). The delay is 17 days, the penalty rate is 10% so an additional $32.30 is due with the $322.95 tax deposit.

$32.30 sounds like a small penalty to pay and some employers fall to the temptation to use the federal government as a lender by not depositing payroll taxes. I have never seen this end well.

The employer loses track of what is owed, or decides "flying under the radar" is easy. How ever it starts the employer eventually receives a notice from the IRS "asking" for the missing deposits. By this time the employer may have failed to deposit several months of taxes and failed to file several quarters of payroll tax reports (Forms 941, 944, TWC form C-3) creating failure to file penalties. And at this point the costs to remedy the situation begin to climb as does my fee. Remember it is easier to do the job RIGHT (and cheaper, faster...) the first time than to go back and do it a second time.

With the FTD penalty comes a second ugly fact of missing the deposit, INTEREST! This is what makes missing the deposit painfully expensive. The interest rate is determined quarterly and is compounded daily using the sum total of unpaid tax and penalties.

Using Tony's Tacos again the interest due when the tax is paid Nov 1st the total due would be $355.75 - the PR tax of $322.95 plus the penalty of $32.30 plus the interest of $0.50. Sounds small until you consider this is for a single pay period. What if Cletus missed the deposit for the entire month of September. For the pay dates of Sept 7, Sept 14, Sept 21, Sept 28. The total tax deposit would be $1,335.69. And what if Cletus makes the payment 6 months late on March 15, 2013. And Tonly's Tacos had received notice form the IRS regarding the missing deposit dated February 5, 2013. The penalty on $1,335.69 would be at the rate of 15% or $200.35 and $19.18 interest at 3% resulting in a total due of $1,555.22 when paid March 15, 2013.

The IRS applies deposits in date made order to liabilities in due date order. They apply the oldest deposit received to the oldest past due deposit liability. This can result in a mis-match of deposits to liabilities if a deposit is missed. Even if deposits made are paid in full the mis-match will result in FTD penalties and interest for shortfall. These add up if permitted to continue or if there are large payrolls.

Failures to deposit payroll taxes result normally from either: a.) willful choice to not deposit, b.) a flaw in the payroll process that results in multiple deposits being missed or made for the wrong amounts. For situation (a) there is little that can be done until the employer chooses otherwise. Fortunetly such employers are rare. Employers in situation (b) need to review their payroll process and identify why deposits are missed or incorrect. Doing this usually results in significant savings as penalties and interest paid are eliminated and other costs once ignored are identified and controlled.

 

 

Tuesday
Sep182012

Deposit of Payroll Taxes

When do payroll taxes become a liability? What is the due date for deposit of payroll taxes?

Payroll taxes become a liability  when payroll is calculated; the pay check date (pay date) is used as the calculation date. In my example, Tony's Tacos the pay date is Sept 14, 2012. For Tony's Tacos the tax liability date is the payroll check date of Sept 14th, 2012.

The due date for payroll taxes is a tad more involved. Here I will only talk about taxes reported using Form 941 Employers Quarterly Federal Tax Return. There are two dates when withheld taxes and the employer and employee FICA taxes are to be deposited. Determination of the correct date is based on the amount of the tax deposit and the employee pay date (payroll check date). A third date is available for employers with a payroll tax liability below $2,500. It is my strong recommendation that an employer follow the monthly or semi-weekly deposit schedule.

  • Monthly: Deposit on or before the 15th of the month following the payday generating the tax liability or;
  • Semi-weekly: Deposit taxes on or before the Wednesday following a payday on Wednesday, Thursday, Friday; on or before the Friday for a payday on a Saturday, Sunday, Monday or Tuesday.
  • With the Quarterly Form 941 if the current quarter and the prior quarter total tax liability does not exceed $2,500 for either quarter. It is highly recommended this not be used and that an employer deposit payroll taxes no less than monthly!

 To determine which of the final two date to use an employer uses a look-back period that starts on July 1st of the year prior to the prior June 30. For Tony's Tacos the look back period for the current year started July 1, 2010 and ends June 30, 2011. This determination is to be made annually before the first payroll of the calendat year. If the sum total of the payroll tax deposits (Form 941 deposits) made in during that period is equal to or exceeds $50,000 the employer would be a Semi-weekly Depositor. If the sum total of the payroll tax deposits made during the Look Back period is less than $50,000 the employer would be a monthly depositor.

New employers that do not have prior payroll history or; are not a successor employer will use the Monthly Deposit schedule for the first year of payroll as they do not have a look-back period. As Tony's Tacos started operations June 1, 2012 it will be using the Monthly Deposit schedule. Tony'w will deposit the $322.95 payroll tax liability for the pay date September 14, 2012 on or before October 15, 2012.

$100,000 Next Day Deposit Rule:

If an employer accrues a $100,000 payroll tax liability on any day of the payroll period the payroll tax deposit is due and payable by the next business day. This rule applys to and replaces the monthly or semi-weekly deposit schedule for any payroll where the payroll tax liability exceeds $100,000. For example if a semi-weekly depositor employer accrued a payroll tax liability of $95,000 on Tuesday and on Wednesday accrues another $6,000 in payroll tax liability the $100,000 next day deposit rule would not apply as the $100,000 threshhold was net met by the employer on either day. The payroll tax deposit of $95,000 would be due on or before Friday following the Tueday and the $6,000 payroll tax deposit would be due on or before the following Wednesday the liabilities were created.

Continuing the example if the same semi-weekly depositor were to accrue a payroll tax liability of $100,000 on Monday then the payroll tax deposit would be due the next business day, here Tuesday. If on Tuesday an additional $30,000 in payroll taxes were accrued only the $100,000 from Monday would be deposited. The $30,000 payroll tax liability of Tuesday would follow the normal semiweekly deposit schedule and be deposited the following Friday.

 

Thursday I will cover the nasty things that can happen when an employer dailes to deposit payroll taxes or makes deposits late.