What has come and gone and what to do about it

It’s getting close to the end of the year and there is some great news and many opportunities for tax savings are in the air.

The first tax story is one that comes with a sense of surprise: The Democrats and Republicans agree on something.  Yes, it’s true.  Both parties have agreed on a new tax bill for post 9/11 veterans.  Companies that employ veterans who have been unemployed for more than six months will receive a tax credit.

The “VOW to Hire Heroes Act” will provide tax credits of up to $2,400 for employers who hire veterans who have been unemployed at least 4 weeks; up to $5,600 for hiring veterans who have been unemployed longer than 6 months; and up to $9,600 for businesses that hire veterans who have service-connected disabilities and have been unemployed longer than 6 months.

Though the unemployment rate among veterans of all ages is actually lower than the overall population, the rate is high among veterans of the current wars, standing at 12 percent, compared with about 9 percent for the population at large. The higher rate is driven largely by widespread joblessness among veterans under 25 years old, whose unemployment rate was 30 percent last month.

Although it will remain to be seen whether or not these credits will create a significant increase of jobs in the workforce, the bill might serve to encourage employers to favor veterans when hiring.

Another worthy year-end opportunity lies in expenditures for new machinery.  If you need to purchase new equipment, this is the time to do so.  It is by far the best deal out there and one that should be taken advantage of.

If you were to buy a million dollar piece of equipment and get 100% financing for it, you would be able to deduct the interest from your taxes. If you have used equipment – the section 179 limitation is still $150,0000 for 2011 and that will be reduced next year significantly. A deduction limit of $500,000, which is up from $250,000 previously is good on new and used equipment.  The limit of equipment purchases is 2 million dollars, which is up from $800,000 previously. There is even a “bonus” depreciation of 100% in section 179 after the $500K limit is reached.  This can also be taken by businesses that exceed the $2 million in capital equipment purchases.  There is a push to include 2012 in this new law, but that may not happen, so if you are thinking about buying equipment now is the time to do it.

So, there are lots of new laws that are in effect for the end of the year, not surprising, trying to bolster the economy. Let’s talk a little bit about what didn’t happen.  It seems as if all the “meaty” issues go tabled and did not pass, while some of the easier bills did.  The federal 3% withholding tax on congress contracts, expected to go into effect for 2012-2013 went off the books.

Another issue that got tabled was the R&D credit.  It was set to potentially increase by 20% next year, and like some of the other hefty issues facing congress, this one got tabled as well.

As a taxpayer, what you can do from now until the end of the year is to keep a close eye on the deficit committee.  It is not beyond the realm of possibility that tax changes could go into place effective the date of their report.   The hope is that both parties continue to work together to create more opportunities for improving the economy and providing individuals with actions they can take as the year ends and the new year begins.

Bad Times for Savings; Good Times for Tax Planning

Interest rates keep going down and this provides great opportunities to do some pretty good tax planning.  Let’s say, for the moment, that you want to make a loan to your children for a house, to start a business, or for something that requires an otherwise substantial loan.  The IRS sets an interest rate called the Applicable Federal Rate (AFR), and if you use it, they will not intervene and try to impose a higher one.

It's a good time to take advantage of low interest rates. Photo courtesy of worradmu and FreeDigitalPhotos.net.

There are three levels of rates and they’re set every month.  Now, get this, the rates set for October are the lowest ones since 1952, when the IRS started giving these AFR rates.  Let’s go through these rates.  Let’s say you have a short term loan, which is defined as a loan of three years or less.  The interest rate for such a loan —if entered to in October 2011— is 0.16%.  You claim that as income and the IRS will not bother you.  For a three to nine-year loan, which is called a mid-term loan, the rate is 1.19%, and for loans over nine years, the rate is 2.93%.

This is an incredible opportunity for anybody who wants to make a loan to their children, for instance, at a very low rate.  Now, someone would be tempted to do the short-term loan and keep rolling it over.  This could be done but, unfortunately, the interest rate will most likely have changed at the end of the first term and it could be higher, so what you want to do is lock the rate that’s most appropriate for the length of the loan.

What has brought about this change?  It’s all based on a number of indices the government uses to determine the AFR.  I think it’s an excellent opportunity to look into succession planning and family planning.

Now let’s say you want to transfer stock to your children and the company is appreciating significantly, but you don’t want to eat into your exemption.  You may remember, you have $13,000 per doni per year you can make, and we have this year —and we hope also next year, depending on what happens in Congress— a $5M exemption curb.

Now, let’s say you don’t want to use those.  You have another option this year, called a GRAT, which stands for grantor-retained annuity trust.  In order to set one of these up for a child, you need to come up with an annuity.  Let’s use a three-year annuity for this example.  You would have to give yourself an annuity which is equal to the amount you put in plus 1.19%, which is the mid-term rate.  Any amount of appreciation in excess of 1.19% goes to the children completely tax-free and without costing you any gift tax.  In the right situation, this is really great.

Obviously, if you think about these lower rates from a savings perspective, it’s a downer.  But you can use it to your advantage.

Now, your children may be able to deduct that money depending on what they used it for.  In tax policy, there’s something called the Interest Tracing Rules.  If the money’s used for a vacation, it’s personal interest and that’s not deductible.  On the other hand, if the money’s used to put it into a business, that’s fully deductible.  If the money’s used to buy a house and the house is secured with a mortgage, this would fall under mortgage interest, which is fully deductible.

Obviously, we don’t know if these deductions will be kept in place.  Both Democrats and Republicans are re-reading Harry Truman’s presidential campaign from 1948, when he campaigned against the “do-nothing” Congress, when he ended up being reelected.

Anyway, both parties would like to pass some type of tax legislation just to show that they are at least trying to ameliorate some of the problems with the economy and to reduce the deficit at the same time.  So I think there’s a pretty good chance that there will be some type of tax legislation soon.  There’s a lot of inertia in Congress to do something before Thanksgiving.

Whatever ends up happening, talk to your CPA or tax advisor now if you want to take advantage of these opportunities.

(In) Decision by Committee

We apparently had a great deal when it comes to the Federal deficit at the beginning of this month, all congressmen congratulated each other, they went away on vacation, and then it all hit the fan.

What’s fascinating is how they’re going to try to fix the problem. With a committee of 6 Democrats and 6 Republicans, is anything really going to happen? Seriously, these lucky congressmen will have their campaigns funded in perpetuity; they will be visited by so many special interest groups in the next couple of months. On top of that, this committee’s meetings will be held in secret. Since the Republicans are not going to agree to any new taxes, I can’t imagine that this committee will permit any type of legislation that can allow that. Not only does that mean tax rates will not increase, but a lot of the perceived inequities in the tax system are not going to be dealt with. This is a serious problem; all we’re going to get is the Republican strategy of cutting programs, both from the defense side and the domestic side.

I know that no one likes to pay more taxes, but there’s something no one’s addressing, namely that taxes will still increase next year. Payroll taxes went down this year, but it’s only for one year; they’ll go up again on January 1st, 2012. The bulk of America does not pay the Alternative Minimum Tax (AMT) because of this increase in the four of the AMT, which allows a lot of taxpayers to take, for instance, their real estate taxes, the state and local taxes, which they could not take if they were in the AMT. That expires in 2012 as well.

So, what happens January 1st, 2013? We get the surtax on non-passive income, like interest income, dividend income, or rental income, all of which is used to pay for Obamacare.

As I said, this is a serious problem. Honestly, I don’t think that Standard & Poor’s move to downgrade our rating was wrong; they see this perceived wad jam in the Legislative and the Executive Branches. They will not make any meaningful changes. S&P said what was required to keep the rating and they didn’t do it.

The Fed decided not to increase interest rates in the next couple of years to help the economy. Is that really going to help it, though? I don’t think so. See, there’s more cash around than ever, but there’s no easy access to it. There’s plenty of cash in the banks and big companies have more of it than they know what to do with, but they’re not going to invest it until they know what the true economic outlook will be in this country, so they’re not going to create jobs, and that’s the problem. There needs to be an economic plan across the board, which small businesses especially can buy into.

This is not 2008. As I said, there’s plenty of cash to go around, so interest rates are not the problem; it’s getting comfortable and having an economic plan, but I think the Fed’s completely missed the boat. I agree with what the minority said, namely that if the rates are kept low, we might end up with inflation. Rates are down but money is still being printed. I must say I agree with the Tea Party in this respect, and I also think that, given how this whole committee is constituted, we have unreal expectations for what will happen. Nothing substantive will be done in the tax law and everyone agrees that it’s onerous and should be simplified.

I used to think we were not going to have much of a state tax in the future. More and more people in Congress are coming to the realization that, by lowering the exemption, they can very well create a lot of revenue, with a constituency of dead people that no one will complain about. Their children might, but in general it’s a very quite constituency. At the end of the day, if they see this Republican freeze about taxes, I think they may very well agree to not change the estate taxes but to reduce the exemption significantly, which will then create more revenue.

But anyway, to end my arguments about the committee, it will be interesting to see what happens if they end up in a 6-to-6 deadlock, which very well may be.