Tax Provisions Of The 2012 American Health Care Act – Part 2

TaxConnections Blogger Harold Goedde posts about the affordable care act

This article will discuss the tax provisions enacted as part of the Act and its implications and hardships that will be created for businesses and individuals.

Tax Planning Considerations to Mitigate the NII

[Blake E. Christian, “Planning for the Medicare Tax on NII”, The Tax Adviser, on line, December 13, 2012]

(1) any interest income from shareholder loans (imputed or otherwise) will be subject to the new surtax. This is the case whether or not the taxpayer’s underlying trade or business is passive or non passive. In the current low-interest-rate environment, taxpayers may be in a position to reduce the interest rate on their related-party loans, potentially reducing the tax liability resulting from the surtax. Another strategy to avoid future interest income is to convert the loan to a contribution to capital.

(2) paying dividends from closely-held corporations. To the extent shareholders and respective businesses have the means to pay a dividend, it may make sense to accelerate payments into 2013. This is especially true if the company feels it has retained cash that the IRS may view as being subject to the accumulated earnings tax under Sec. 531.

(3) S corporations may have accumulated earnings and profits (E&P) from a prior C corporation tax year, which may be distributed before amounts from the accumulated adjustments account (AAA), provided certain elections are made. Additionally, tax-deferred income of domestic international sales corporation (IC-DISC) may be available for distribution to the shareholder in the form of a dividend, which can escape the new tax by paying the dividend payment before the end of 2013. For further details on dividend distribution ordering, E&P, AAA, and related information, see Christian, “AAA, PTI and E&P”, Corporate Taxation Insider, August 28, 2008].

(4) Other considerations (c)(a) converting traditional IRAs into Roth IRAs in 2013, if this otherwise makes sense from a long-term planning perspective. This will effectively reduce MAGI in future years when taxpayers take distributions from the accounts.

(b) Investing in tax-exempt bonds rather than taxable bonds.

(c) Taking capital losses to offset capital gains to reduce NII.

(d) Managing retirement plan distributions to maintain MAGI that does not exceed the “threshold amounts” of 200,000 and $250,000. It may not be possible to reduce these if you are subject to the annual required minimum distribution from a tax deferred retirement plan (IRA, 401k, 403b, etc) but this can be reduced by making a direct charitable donation up to $100,000 of all or part of the required minimum distribution.

(e) Evaluating whether investment income currently, or in the future, is held in a pass-through entity (partnership or S corporation) vs. a C corporation.

Proposed Regulations

On November 30, 2012, the IRS issued proposed regulations (REG 130507 11) on NII that provides additional guidance on what constitutes NII. It further defines “trade or business” income for purposes of the new surtax. Under the proposed regulations, Sec. 162 applies when defining a trade or business. Therefore, an activity may be a passive activity under Sec. 469, but if it constitutes a trade or business under Sec. 162, it may not be NII for this purpose. The proposed regulations provide useful details regarding the suggested application of the new NII rules. The regs address the following situations:

(1) portfolio income earned on working capital of an active trade or business will always be viewed as NII, regardless of whether the business owner’s role is active or passive [Prop. Regs. Sec. 1.1411 6)].

(2) for the sale of a partnership interest or the stock of an S corporation, the proposed regulations assume hypothetical gains and losses on a fair market value sale of the underlying assets held by the partnership or S corporation similar to the Sec. 338(h)(10) election). The gain or loss on the deemed sale of an asset will not be included in the calculation of NII if the asset is held in a trade or business (other than a trade or business of trading in financial instruments or commodities) of the S corporation and the owner was active with respect to that trade or business. The gain or loss on the deemed sale of property not held in a trade or business of the S corporation will be included in the calculation of NII [Prop. Regs. Sec.1.1411 7].

(3) net gains and losses associated with distributions or liquidation of a partnership/LLC or an S corporation will virtually always be treated as NII and will be subject to the NII tax for both passive and active owners [Prop. Regs. Sec. 1.1411 4].

(4) deferred or excluded income items, such as from Sec. 1031 or 1033 exchanges or sale of a personal residence, etc., are generally excludable from the tax [Preamble to REG 130507 11].

All individual taxpayers estates and trusts even with even low taxable income levels and relatively high incomes and various passive investments, will experience increases in federal tax beginning in 2014. Changes in portfolio allocations, including moving to more tax-exempt bonds and/or non-dividend-paying stocks, may yield long-term tax savings. To the extent taxpayers can control their MAGI from year to year to stay under the applicable thresholds, the NII may be avoided altogether For more information on this topic see “Recent Developments in Estate and Trusts Planning Part 1”, by Justin P. Ransome, J.D., MBA, CPA, and Frances Schafer, J.D, The Tax Adviser, online edition, September 1, 2013.

The IRS released a draft of form 8960 which will be used to compute the tax for individuals, estates, and trusts. There will be no withholding for this tax. Taxpayers should review the form and/or consult with their tax adviser to determine if they need to adjust withholding and estimated tax payments for any additional tax resulting from NII.

Mitigating the Tax on NII

If you expect to have a large gain from sale of investment real estate, consider an installment sale to spread the gain over several years. An alternative if you are considering selling real estate and may want to acquire similar property, rather than sell the present property and re-purchasing new property, use a “like-kind”, tax-deferred exchange. Unless boot is received, any realized gain (fair value of property received less adjusted basis of property given up and fees paid) is not recognized and reduces the basis of the property received. The realized gain is deferred because it reduces the basis of the property received on the exchange and in a sense is recognized when the replacement property is sold. Any gain that is not recognized, reduces the basis of the property acquired. When you do a “like-kind” exchange, be careful not to receive any additional property or money (boot) on the exchange. If you receive boot, a gain is recognized to the extent of the lesser of the boot received or the realized gain. If you give boot, it is added to the basis of the property acquired. If you have sold securities for large gains and have other securities with unrealized losses, consider selling these to offset capital gains and up to $3,000 of ordinary income. If you are 70 and a half, or older, you can donate up to $100,000 of the required minimum distribution directly to charity from your IRA. By doing this, you avoid including all or part of the required minimum distribution in income. This will reduce MAGI used to compute the tax on NII [Kiplinger’s Personal Financial Adviser, August 2013].

See Part 3
See Part 1

In accordance with Circular 230 Disclosure

Dr. Goedde is a former college professor who taught income tax, auditing, personal finance, and financial accounting and has 25 years of experience preparing income tax returns and consulting. He published many accounting and tax articles in professional journals. He is presently retired and does tax return preparation and consulting. He also writes articles on various aspects of taxation. During tax season he works as a volunteer income tax return preparer for seniors and low income persons in the IRS’s VITA program.

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