Archive for July 2nd, 2012

While the Supreme Court’s decision to uphold Obamacare has left half of the nation readying plans to renounce their citizenship and flee to Canada, the rest of us who stick around have to deal with the aftermath. And while to date, the individual insurance mandate has been the target of much of the ire, my guess is that sooner rather than later the nation’s attention will turn where it likely belongs: on the 3.8% surtax set to be imposed on investment income beginning in 2013.

The surtax will apply only to those with AGI in excess of $250,000 ($200,000 for single taxpayers), but when coupled with the slated increase in the preferential tax rates currently afforded long-term capital gains and qualified dividend income should the Bush tax cuts expire, those taxpayers affected by the increase are staring at a doubling — or in some cases tripling — of the tax rates they currently pay.  

To illustrate, should the Bush tax cuts expire, the tax rate imposed on long-term capital gains is set to rise from 15% to 20%. Tack on the 3.8% surtax for appropriate taxpayers, and you’re looking at a 8.8% rise from 2012 to 2013, an increase that will — and should — have taxpayers considering accelerating the sales of investments and businesses into 2012.

Similarly, courtesy of the Bush tax cuts, taxpayers have enjoyed a 15% tax rate on qualified dividend income for over a decade. Should those cuts expire, all dividends will again be taxed at a top rate of 39.6% plus the 3.8% surtax, meaning the dividend rate will increase from 15% to 43.4% with the turn of the calendar.

Of course, few experts expect the Bush cuts to expire at year-end; rather, a short-term patch is the more likely answer. In that case, the top tax on both long-term capital gains rates and qualified dividends will increase only by the 3.8% surtax — from 15% to 18.8%, while the top rate applied to interest income will increase from 35% to 38.8%.

While the leading question facing questions in light of the increasing tax rates may well be, “Should I sell my business in 2012?” there are other concerns that need to be addressed as well.

For example, assume a client owns many rental properties that, in total, generate significant income. An election treat the taxpayer as a “real estate professional” under I.R.C. § 469(c)(7) has never been necessary, because the taxpayer is not generating losses. In fact, you’ve preferred to treat the client’s interests in the rental activities as passive, because the client has other non-rental passive investments that generate losses and can partially offset the passive rental income.

But starting in 2013, the 3.8% surtax is slated to be applied not only to long-term capital gain, dividend and interest income, but also to rental income. While the Patient Protection Act is largely bereft of guidance on how the surtax will apply to rental income, certain questions are raised:

If I don’t make the election to treat the client as a real estate professional, does all the rental income become subject to the 3.8% tax, or would material participation suffice?

If material participation will suffice, will I need to make the election to aggregate all the activities in order to meet the tests under Section 469?

If I make the election, the rental activities are no longer treated as passive. Thus, the non-rental passive losses the client generates will no longer have passive income available to offset, and will be suspended under I.R.C. § 469. Is trading the 3.8% surtax for the inability to use the passive losses worth it?

I don’t know the answer yet, and in all likelihood, neither does the IRS, since they have not issued formal guidance, likely waiting like the rest of us to see what the Supreme Court decided to do with Obamacare.

Of course, even with the Supreme Court’s blessing, the fate of the surtax is still shrouded in a bit of uncertainty, as there is the matter of the election to come this November. Should Mitt Romney prevail, the first thing on his to-do list would be to repeal the Patient Protection Act, and send the 3.8% surtax with it. Should that happen, it would make the decisions to accelerate investment income into 2012 — whether on the sale of publicly traded stock or closely held business look rather rash and ill-conceived.

In the meantime, however, I’ve scoured the interwebs, and as she always does, Laura Sanders over at the WSJ did a great job dissecting the the looming surtax. I highly recommend you give it a read.

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A few things you may have missed this weekend while watching Spain put on a clinic.

New Jersey Governor Chris Christie wanted a 10% tax cut included in the latest state budget, but didn’t get one. So as punishment, all state lawmakers are required to spend a 100-degree afternoon in downtown Trenton so Christie can give them a talking to. Good times.

Dwight Howard wants the Orlando Magic to trade him to the Brooklyn Nets. So to clarify: not only is he demanding to be sent to a team that won all of 22 games last season, but assuming he relocates from Florida to New York, he’s also insisting on a 8.82% salary cut in the form of increased state income taxes. Smart fella’.

How to protect yourself against tax identity theft.

Robert Wood over at Forbes discusses the tax implications of the Katie Holmes – Tom Cruise divorce. As an aside, many people are using the divorce as an opportunity to renew their attack on Scientology —  the new-age religion of which Cruise is a devote —  blaming Cruise’s faith for the split. These critics call Scientology a farce, pointing out its spurious genesis and  “outrageous” belief system, with some high-profile people going so far as to call the religion “evil.”

I, for one, find these types of attacks on any religion — fringe as it may be — to be rather narrow-minded.  When I was a kid, my parents taught me all about another so-called “wicked” guy, who had long hair and some wild ideas, and who didn’t always do what was right, but today he has countless followers who love and worship him. I’m drawing a blank on the guy’s name right now, but I remember he used to drive a blue car.

As an aside to my aside, I had dinner with some clients/friends on Friday night, and a spirited debate broke out over what I always thought was a no-brainer of a question: What is the most homoerotic movie scene in cinematic history?

Now, I’d been of the belief that this was an open-and-shut case, with the “Apollo Creed/Rocky Balboa frolicking in the shore break” scene from Rocky III as the only acceptable answer:

My client, however, insisted that the famous Tom Cruise volleyball scene from Top Gun took the prize:


Decide for yourself, but I hope Mike and I can come to an agreement on this soon, as this is the type of argument that can irreversibly damage the CPA-client relationship.

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