Archive for the ‘investment advisory fees’ Tag

Back to Basics Part XXXV – Form 8959 Additional Medicare Tax and Form 8960 – Net Investment Income Tax

Originally published in the Cedar Street Times

March 25, 2016

Forms 8959 and 8960 are two relatively new forms that started with the 2014 tax year.  These are two of quite a number of tax increases that are being used to help fund ObamaCare.  Both of these forms affect people with income in excess of $200,000 for Single filers or 250,000 for Married Filing Jointly.

Form 8959 is the Additional Medicare Tax.  It is an additional 0.9% Medicare Part A tax on combined W-2 and self-employment wages in excess of the above stated thresholds.  Note that it is not based on  W-2 box 1 taxable wages, but on Medicare wages which are often higher for most people.  Pretax deductions such as contributions to retirement plans are included in Medicare wages, whereas they are not included in box 1 taxable wages.

Employers have to start collecting this additional tax once your wages hit the thresholds.  However, if you changed jobs during the year, the second employer will not withhold until the wages your earn with that employer reaches the thresholds.  This means that you could owe additional tax when you file your tax returns for the shortfall, since the new employer and old employer do not communicate to coordinate this tax.  For self-employed people, you would of course be sending in quarterly estimates of your income and self-employment tax liability, and the calculation of this new tax would be made on your income tax returns at year-end.

The Form 8960 is the Net Investment Income Tax (NIIT).  Once your income meets the thresholds previously discussed, you will also have an additional 3.8% tax on all investment related income.  This would include income sources such as interest income, dividend income, annuities, rents, royalties, capital gains distributions from mutual funds and capital gains from the sale of investments such as stocks and bonds.  Even real estate professionals would be subject to NIIT on their own rental real estate activities, unless they meet the material participation test specifically in rental real estate, which is a separate test from time spent in real estate sales activities, for instance.

If you own an interest in a business and you are not materially participating in the business, this income will also be subject to the net investment income tax.  Material participation generally means 500 hours or more during the year.  The sale of rental property and even second homes are also subject to NIIT.  If you sell an interest in a partnership or s-corporation and do not materially participate in the business, you will also be subject to NIIT on any gains from those sales.  Investment income from your children that are taxed on your returns through Form 8814 are also subject to NIIT.

Wages, unemployment compensation, alimony, Social Security benefits, tax-exempt interest income, income subject to self-employment taxes, and income from qualified retirement plan distributions are specifically excluded from the tax.

There are also some deductions that can be used to offset NIIT.  These expenses included investment interest expense, investment advisory and brokerage fees, expenses related to rental and royalty income, tax preparation fees, fiduciary expenses (in the case of an estate or trust) and state and local income taxes.

Regarding trusts and estate, it is important to note that the thresholds for NIIT are much lower.  Due to the compressed income tax bracket structure, NIIT kicks in when the trust or estate reaches the highest income tax bracket at only $12,300 of income (2015).  This provides additional incentive for trustees to push income out to the beneficiaries since many trusts will be subject to NIIT, but the beneficiaries are often not subject due to the much higher thresholds for individuals.

Planning can be an important tool to lower the impact of NIIT.

If you have questions about other schedules or forms in your tax returns, prior articles in our Back to Basics series on personal tax returns are republished on my website at www.tlongcpa.com/blog .

Travis H. Long, CPA, Inc. is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. Travis can be reached at 831-333-1041. This article is for educational purposes.  Although believed to be accurate in most situations, it does not constitute professional advice or establish a client relationship.

Back to Basics Part XXII – Form 6251 – AMT

Originally published in the Cedar Street Times

September 4, 2015

AMT, or “Alternative Minimum Tax” was enacted in 1969 in response to a disturbing report by the Secretary of the Treasury that 155 taxpayers with adjusted gross incomes over $200,000 paid zero tax on their 1967 tax returns.

In its simplest form, AMT is a separate taxation system with its own set of rules that runs parallel to the regular tax system.  You are supposed to run the calculations under both systems, and if the AMT system says you owe more tax than the regular system, then you pay the incremental difference as “AMT.”  That incremental difference shows up as additional tax on Line 45 (2014) of your Form 1040.  The calculation of AMT is summarized on Form 6251 and accompanying worksheets, as well as AMT versions of traditional schedules.

The irony of the AMT system is that most of the loopholes it was originally designed to prevent, no longer exist, and it has become a tax that affects the middle and upper-middle class more than the wealthy, yet we still have it and all of its complications.  Today, those who are subject to it, despise its existence, and not many people fully understand it, tax practitioners included.

For people still preparing returns by hand, AMT is an absolute nightmare since many of your other schedules have to be calculated a second time using AMT rules.  For instance, depreciation rules differ between the AMT system and the regular system, as accelerated depreciation methods are generally not allowed.  This means you have to keep an entirely separate set of depreciation schedules just for AMT.  And to make matters more complicated, California does not conform to all of the Federal AMT rules either.  So now you end up with four sets of depreciation schedules – Federal regular, CA regular, Federal AMT, and CA AMT.

I do not think I have ever seen a hand-prepared return done correctly when AMT is involved.  (Actually, in the last ten years, I do not think I have seen any hand-prepared returns done correctly!)

So when do you hit AMT?  It depends.  AMT is calculated on taxable income under about $185,000 at a flat 26 percent rate, and income over that mark at 28 percent.  There is a $53,600-$83,400 AMT exemption amount depending on filing status.

Compared to the regular system, the standard deduction is thrown out (meaning itemizing is your only option), your normal exemptions for yourself, spouse and dependents get the boot, as do many itemized deductions such as state taxes, real estate taxes, mortgage interest on home equity debt (if the funds were not used to improve your home), unreimbursed employee business expenses, tax preparation fees, investment advisory fees and more.

As mentioned before, depreciation methods are not as generous, also ISOs and ESPPs have less tax-friendly rules, investment interest can be hacked, and a whole bunch of other specific differences that apply to certain situations.

Since some people will have more AMT adjustments and preferences than other people, there is no set dollar threshold that will trigger AMT.  That said, I feel that I rarely see it for a Married Filing Joint return with under $100,000 of adjusted gross income.  It also starts phasing out for people with high incomes.  The top AMT rate is 28 percent, but has fewer deductions than the regular system.  Besides a handful of lower brackets, the regular system also has 33, 35 and 39.6 percent brackets, but with more deductions.  At some point, however, the higher tax rates outweigh the additional deductions and the regular system results in more tax than the AMT system. You may pay no AMT once you get to $600,000 or $700,000 of income, depending on your AMT adjustments.

People in AMT that are employees often feel trapped, especially those in the sales industry that are used to generating a lot of deductions from vehicle mileage and other expenses their employers do not reimburse.  It does not matter how many unreimbursed expenses they come up with, they will all get thrown out in the AMT system.

For people that flip back and forth between years of AMT and no AMT, there can be a minimum tax credit generated by the AMT you paid that can be helpful.  If you paid AMT in one year, and the next year the regular tax system is higher than the AMT system, you can get a credit against your regular tax to the extent of the difference between the two tax systems limited to the credit amount generated by certain deferral type AMT adjustments/preferences.  Got it?  Just trust me, sometimes it can help!  There are also sometimes when flipping can be a negative…fairness is not always the result of our tax system.

The best news we have had about AMT in recent years was that in 2013 Congress finally legislated an annual inflation adjustment for the AMT exemption.  For years Congress was in a habit of passing an AMT patch in late December or January to make up for the fact that the exemption was not inflation adjusted, and would return to 1993 levels if nothing was done.

Tax professionals were biting their nails some years wondering if it would happen.  The impacts on middle class Americans would have been tremendous, and many were oblivious.  I read estimates in 2011 that 4 million taxpayers were subject to the AMT, but without a patch that number would have swelled to 31 million!  I can remember running scenarios for a family making around $100,000 and realizing they would have a surprise tax bill of an additional $2,000 or so without a patch.

The form itself is only two pages.  Part I is a summary of all the adjustments and preferences that differ from the regular tax system, to arrive at Alternative Minimum Taxable Income (AMTI).  Part II deals with calculating your AMT exemption, your Tentative Minimum Tax (tax calculation under the AMT system), and then the AMT itself (the amount your Tentative Minimum Tax exceeds the regular tax system amount).  Part III is a supplemental calculation that feeds into Part II when your return includes capital gains, qualified dividends, or the foreign earned income exclusion.

If you have questions about other schedules or forms in your tax returns, prior articles in our Back to Basics series on personal tax returns are republished on my website at www.tlongcpa.com/blog .

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.