2011 Tax Changes (through November 9, 2011)

If you've been following the Republican primaries then you probably have heard of something called the “flat tax”. Each front runner – Romney, Perry and Cain have their own versions. I promise I won't go into detail!

The big question most people have is whether they would be better off with the flat tax than they are with the current system. The thing to keep in mind is that “flat”, in the true sense of the word, means that each taxpayer would pay the same percentage on their income. If the rate was 10%, then the person who earned $20,000 would pay $2,000 in tax and the person who earned $200,000 would pay $20,000. This compares with the current system where single person with a taxable income of $20,000 would be in the 15% tax bracket and a single person with $200,000 of taxable income would be in the 33% tax bracket.

The latter is what they call a “progressive” tax system where people with higher incomes pay more as a percentage. The flat tax is known as a “regressive” system because lower income taxpayers have a greater burden, relative to available resources, than do those that have higher incomes.

So under a true flat tax system, lower and middle class taxpayers are likely to be worse off and higher income taxpayers are likely to be better off.

Of course, none of the systems as proposed, are true flat taxes but every analysis I've seen so far comes to the conclusion that the proposals are more regressive than the current system.

Of course, Perry's plan allows you to calculate your taxes two ways, under his system and under the current system, and send in the smaller result of the two. Now that's what I call a “tax preparer full employment act”!

Not to defend the current system but make sure you understand what you are buying before you get caught up in the euphoria of a “fair” tax.

Making Work Pay

The last two years (2009 and 2010) everyone with wages or self-employment income (and even some without) received what was known as the Making Work Pay Credit. The credit maxed out at $400 for singles and $800 for marrieds. That credit is gone now but it was replaced with a 2% reduction in the amount of Social Security tax you need to pay on those earnings. You've actually been receiving that 2% all year – a little bit in each paycheck.

So were you better off with the Make Work Pay Credit or with the 2% reduction? If you are single and earn $10,000 your Make Work Pay Credit would have been $400. Your savings this year will be $200. If you are single and earn $100,000 your savings under the credit were $0 (you were phased out). This year your savings will amount to $2,000.

Both the Making Work Pay Credit and the Social Security Tax Cut are stimulus programs, i.e. bailouts for us average folks. Since stimulus is now a dirty word in Washington don't look for this one to be extended beyond its 12/31/11 expiration date.

Health Savings Accounts

Beginning January 1 of 2011, the cost of nonprescription drugs was no longer a qualifying expense. Using HSA funds to purchase these items will result in tax and penalty. Insulin and nonprescription drugs that are prescribed by a physician are exceptions.

2011 Health Savings Account Contribution Limits are as follows:

Single Coverage - $3,050

Family Coverage - $6,150

Add $1,000 if age 55 or older.

The Estate Tax Is Back!

But it will only impact you, in 2011 if you die with more than $5,000,000 in assets. I think I'm safe!

Without further legislation, however, the 55% maximum estate tax rate and the $1,000,000 estate tax exclusion will return in 2013.

Look for this to be a big issue in the upcoming Presidential elections.

Mileage Rates

They did it again! Since gas prices showed such a rise in the first half of the year we have different mileage rates for the first half of the year than we did for the last half of the year. That means you need to determine how many miles were driven from January through June versus July through December! The rates are as follows:

The IRS cannot adjust the charitable mileage rate. That will take an act of Congress. Seriously!

Adoption Credit

For 2011 and 2012 the adoption credit stays at $13,170 per eligible child. Expenses qualifying for the credit include adoption fees, attorney fees, court costs, and travel expenses.

The credit is also refundable which means you can still get it even if you have no tax liability.

After December 31, 2012 the credit will only be available for special needs adoptions and will be reduced to $6,000. Strike while the iron's hot!

Energy Credits

An extension of the home improvement energy credit for 2011 brings back the same structure and rates that existed in 2066 – 2007. That means, among other things, that windows, doors and skylights that meet the Energy Star standards will all qualify. Qualifying improvements include insulation, exterior windows and doors, central air conditioning, new furnaces, and new wood stoves along with some other items. The credit is now 10% (down from 30%) of the cost of the property with a total cap of $500 (down from $1,500). The $500 cap needs to be reduced for all credits claimed from 2006 onward. Of the total $500 credit, only $200 can relate to expenditures on windows.

The credit for solar, geothermal, wind and fuel cell property continues until 2016.

Expired Tax Provisions

In addition to the Make Work Pay Credit there were a few other tax provisions that expired as of the end of 2010

- Deduction for health insurance costs in computing self-employment taxes: It was nice while it lasted, one whole year, but this provision allowed self-employed individuals to deduct health insurance premiums paid from self employment income for purposes of calculating the self-employment tax.

- First Time Homebuyer Credit: this actually ceased to exist for everyone on September 30, 2010.

- Payroll tax forgiveness for hiring unemployed workers: This provision allowed employers to keep their half of the Social Security and Medicare taxes they would otherwise have to pay if they hired someone who had been unemployed for two months or longer.

- The credit for purchasing a hybrid auto or light truck.

Expiring Tax Provisions

For planning purposes, the following provisions will be expiring after December 31, 2011 unless otherwise extended by Congress.

- The Non-business Energy Credit. See the earlier discussion on “Energy Credits”

- Credit for electric drive motorcycles, 3-wheeled vehicles, and low speed vehicles: I guess this was a fairly popular credit in certain, warmer parts of the country, but up here in northern Wisconsin? Nah!

- Educator expense deduction: this allows K-12 teachers, instructors, counselors, principals and aides to deduct up to $250 of books, supplies and materials used in the classroom as a deduction to adjusted gross income. Normally these expenses are only deductible if the person itemizes.

- Deduction for State and Local General Sales Taxes: For those who itemize their deductions, they can either take the amount of income taxes they paid to States or the amount of sales taxes they paid. This mostly benefits those who live in States without an income tax. If a certain individual from Texas gets elected President, look for this to be extended!

- 100% Additional First-Year Depreciation: For businesses only, this allowed a 100% current year deduction on new assets. Since Wisconsin didn't follow federal on this provision we would usually accomplish the same result by using Section 179 thereby avoiding a different depreciation schedule for federal than we have for Wisconsin.

- Special Rules for Conservation Contributions of Real Property: This was to encourage people to make contributions, such as conservation easements, that would benefit society. The provision increased the AGI limitation for conservation contributions.

- Deduction for Qualified Tuition and Related Expenses: Most people are better off with the credits anyway.

Rental Property Owners

In last year's newsletter, we reported that, beginning in 2011, you were going to have to issue 1099's to report payments to service providers, such as plumbers, electricians, and painters. You'll be happy to note that provision was repealed so you will not be required to issue those 1099's.

Spam Alert

The subject could be “Tax Report” or “Federal Tax Payment Rejected” or “Treasury Inspector General of Tax Administration” or something else we haven't seen yet but all the emails want you to click on a link to take care of some problem. DON”T DO IT! The IRS does not correspond with taxpayers via email. These are scams and clicking on the link will download malicious software to your computer.

Who Would Have Guessed?

- Notice 2011-14 tells us that the cost of breast pumps and lactation supplies are deductible as medical expenses. This is because, like obstetric care, their use is for the purpose of affecting a structure or function of the body of the lactating woman. Amounts reimbursed for these expenses under flexible spending arrangements, Archer medical savings accounts, health reimbursement arrangements or health savings accounts are not income to the taxpayer.

- Rolfs v. Commissioner – A couple did not make a charitable contribution when they donated a house for firefighter training because the demolition services they received exceeded the value of the house.

- The Social Security wage base will increase in 2012 to $110,100. This is up from $106,800 in 2011. This is the first increase in the Social Security wage base since 2009.

- Per the Kiplinger Tax Letter, the IRS isn't timely responding to taxpayers. A Treasury Inspector report concludes the Service isn't meeting its goal of answering taxpayer correspondence within 30 days. As a result, taxpayers keep getting erroneous notices after mailing documents to resolve a dispute.

- The cost of special day camps, such as math, computer, theater or soccer camps as well as reading, writing and study skills camps qualify for the dependent care credit. However, the cost of summer school or tutoring programs don't qualify because they are treated as education, not care. In other words, math camp is not educational! Go figure.

- Wisconsin and Ohio are the two midwestern States where the IRS is checking real estate transfer returns. What are they looking for? People who failed to file a gift tax return (Form 709) on transfers of real property to family members for little or no consideration. If you transferred some property that amounted to a gift of more than $13,000, you may want to get a jump on it.

- The average audit rate in fiscal 2010 was 1.11%. If you had a business with gross receipts greater than $25,000 or claimed the earned income credit, your audit rate was double that.

- This from Kiplinger Tax Letter – Bedbugs aren't just a problem in hotels, the IRS has them too. The critters have infiltrated several IRS offices, so the agency and its employee union have reached an agreement on how to handle them. When and infestation is confirmed, a pest technical and a pest-sniffing dog will come in to find and kill the varmints. At least taxpayers get better treatment from the Revenue Service than bedbugs.

And there you have it!

2011 Tax Changes For Business

New Form 1099-K

If you accept credit cards in your business, you'll likely see a new 1099 in your mailbox towards the end of January. The 1099-K requires a payment settlement entity (your credit card company) to issue this document to you reporting the gross receipts you received by credit card. You will report these receipts separately from other income received.

On the opposite side, if you pay bills by credit card, you will no longer be including those amounts in a 1099 to those individuals or businesses. To do so would result in the individual receiving 1099's that report the same income more than once.

If you make payments to corporations you will not need to provide them with a 1099. Previous legislation that would have required 1099's to corporations has been repealed.

Business Use of Personal Vehicle

This is not a change, but I see enough problems in this area that I felt it was worth discussing.

The mileage deduction for many small businesses and sole proprietors is major and can have a huge impact on the net income of your business. This, in turn, greatly impacts how much income tax and self-employment tax you end up paying. Would you do anything that might endanger that deduction?

Many small businesses do just that because they do not follow the proper guidelines related to substantiating the business use of a personal use vehicle. If the use of that vehicle is not substantiated in the proper way the IRS can, and quite regularly does, deny any deduction for business use of personal vehicles on audit. How would that impact your pocketbook?

A personal vehicle is any vehicle that could be used for personal purposes even if it's not. It does not include specialized vehicles, such as a garbage truck, or vehicles that have been modified so that they are not likely to be used more than a minimal amount for personal purposes. Modifications could include the installation of permanent shelving, or providing seating for only the driver.

So what are you required to do? In order to document the business use of that vehicle you are required to keep a log. For each day, mark down the beginning odometer reading, where you are traveling, the business purpose for that travel, and the odometer reading at the end of the day. Also make note of the odometer reading on the morning of January 1 and the evening of December 31.

You can account for several uses of your vehicle that can be considered part of a single use, such as a round trip or uninterrupted business use, with a single record. As an example, if you are on a three day business trip you can make one record entry for that trip rather than making an entry for each day of the trip. Minimal personal use, such as a stop for lunch on the way between two business stops, is not an interruption of business use.

So what mileage is deductible? If the major part of a trip is related to business, it will be classified as a business trip and all mileage will be deductible except those miles that pertain to a personal activity. As an example, say you are attending a trade convention in Denver. All mileage going to and returning from Denver will be deductible business mileage. While you are in Denver, though, you decide take a drive up to the top of Pike's Peak. That would be personal mileage and not deductible.

On the other hand, just because you make a business stop on a personal trip, it doesn't magically turn the whole trip into a business trip. As an example, you drive to Eau Claire to visit family. While there you stop at a big box store to purchase some business supplies. The only deductible mileage in this scenario is the additional mileage to stop at the big box store.

Mileage from your home to your place of business or temporary work location if it is within your “metropolitan” area (generally defined as 30 miles or so in a rural area) is non-deductible commuting mileage. As an example, you live in the country but have your business in town. The mileage from your home to your place of business in the morning and back home in the evening is personal commuting mileage and is not deductible.

2011 Wisconsin Changes

College Savings Account Subtraction

Beginning January 1, 2011, the owner of a college savings account may authorize another person to make contributions to the same account. This effectively eliminates the requirement of setting up a separate account to take that contribution, even if the beneficiary was the same person.

In order for the contributor to take the subtraction on the WI return, the beneficiary must be the contributors child, grandchild, great grandchild, niece or nephew.

Subtraction for Tuition Expenses Limited

If tuition expenses were paid from a college savings account where the contributions to that account were claimed as a subtraction on a Wisconsin return, they cannot again be subtracted as tuition paid.

On a positive note, the subtraction has been increased to $6,185 per student from $6,000 in 2010.

Earned Income Tax Credit

The percentage of federal Earned Income Tax Credit for two qualifying children was reduced to 11% from 14% and the percentage for three qualifying children was reduced to 34% from 43%.

Health Savings Accounts

Wisconsin is now same as federal. There will be no add-backs, beginning in 2011, for contributions to a health savings account. Of course, now we have the problem that some of the account will be made up of pre-2011 contributions. A worksheet will make the assumption that all pre-2011 contributions will be spent first.

The penalty for taking a distribution from an HSA for other than medical expenses is 33% of the federal penalty.

Medical Care Insurance Subtraction

For individuals with no employer and no self employment income, the full amount paid for medical care insurance is now a subtraction. This is up from 66.7% in 2010.

Individuals who are employees and the employer pays a portion of the medical care insurance can subtract 25% of their out-of-pocket cost for that insurance. This is up from 10% in 2010.

Job Creation Deduction

Beginning 2011 businesses may claim a deduction based on the increase in the number of full time employees. The deduction is equal to $4,000 per eligible employee for businesses with gross receipts of $5 million or less. Child Care Expenses Subtraction

New for Wisconsin, parents who pay child care expenses can subtract up to $750 for one child and $1,500 for two children from their Wisconsin income.

Health Care Benefits for Children Under Age 27

If your employer provides health care benefits to your child who is under age 27, it is exempt under the new health care bill.

Last year, we reported that for Wisconsin, if that child was not your dependent, the value of that health care benefit would be taxable.

Just kidding! On November 7, 2011 Governor Walker signed legislation aligning Wisconsin law to federal retroactive back to January 1.

Paying Estimated Tax?

You can now do it online at https://tap.revenue.wi.gov/#

Campaign Fund Designation of $3.00 Repealed

Nuff said.

Geary N. Searfoss CPA, LLC

Geary Searfoss, CPA, EA, CF

P.O. Box 358, 5114N South Main Street

Winter, WI 54896-0358

Phone: 715-266-8290 Email: gscpa@centurytel.net

Note: the tax changes listed in this newsletter are not all of the changes made during the year to our tax system. I sorted through the changes to bring to you those items that, based on my client demographics, would likely be of most interest.