New Tax on Investment Income
A new 3.8% Medicare tax on the "unearned" (investment) income of higher income individuals will take effect in 2013. It's not too soon to look at potential strategies for minimizing the tax if you're likely to be subject to it.
Who Will It Affect?
The new tax will be imposed on taxpayers who have any amount of net investment income and modified adjusted gross income
(AGl) that is greater than:
- $200,000 (single; head of household)
- $250,000 (married filing jointly)
- $125,000 (married filing separately)
The tax is computed by multiplying the 3.8% tax rate by the lesser of (1) net investment income or (2) the excess of modified AG lover the threshold for your filing status.
Example . Gary, a single taxpayer, has 540,000 of net investment income and total modified AGI of $260,000 in 2013. His tax will be 3.8% of $40,000, since $40,000 is less than $60,000 ($260,000 modified AGI minus $200,000 threshold for a single filer).
If Gary's modified AGI instead totals 5199,999 - and it includes the same 540,000 of investment income - he won't owe the 3.8% tax.
What's included in Investment Income?
Taxable interest, dividends, rents, royalties, annuities, and capital gains are all considered to be investment income. 80 is income from a business investment if you don't "materially participate" in the business.
Various planning strategies may be appropriate if the 3.8% Medicare tax is a potential concern. Consult with us.*
S Corporation Shareholder Salaries:
Keep Them Reasonable
Owners of S corporations who are employed by their companies should make sure their firms pay them reasonable salaries. Although 8 corporation income also can be paid out in the form of cash distributions to shareholders, the IRS is on the watch for companies who pay shareholder-employees nominal salaries in an attempt to minimize federal employment taxes. In the IRS's view, distributions must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.
What Is a "Reasonable" Salary?
The tax law has no hard-and-fast guidelines regarding what is considered "reasonable." When the issue has come up in court, the determination has been based on the facts and circumstances of the particular case. Various factors have come into play, including:
- Duties and responsibilities
- Time and effort devoted to the business
- Training and experience
- What comparable businesses pay for similar services
- Timing and manner of paying bonuses to key people
- Payments to employees who are not shareholders
- The corporation's dividend-paying history
- Compensation agreements
- The use of a formula to determine compensation
What about an S corporation officer shareholder who doesn't perform any services for the corporation - or whose services are very minor? In this relatively unusual situation, assuming the officer receives no direct or indirect pay, he or she would not be considered a corporate employee.
Payroll Tax Cut Extended
The Middle Class Tax Relief and Job Creation Act of 2012 extends the 2% payroll tax cut through the end of 2012. Employees will pay a 4.2% Social Security tax on wages up to $l10,100, and self· employed individuals will pay a 10.4% Social Security self· employment tax on self·employment income up to $110,100.
Tax Code Changes
According to the IRS, approximately 4,430 changes were made to the tax code from 2001 to 2010, an average of more than one a day. In 2010 alone, an estimated 579 changes were made.
Portability Election Deadline Extended
The IRS recently announced that estates of married individuals who died during the first six months of 2011 and had assets of $5 million or less will now have until 15 months after the decedent's date of death, instead of the usual nine months, to file an estate·tax return to make an election to pass along the decedent's estate· and gift·tax exclusion amount to a surviving spouse. See us for details.
May 2012 Page 2