Monday, November 19, 2012

Variable Annuities

I have been saying variable annuities are probably the world's worst investments for a long time.  Here is an article from Smart Money Magazine that says basically the same thing:

And the Securities and Exchange Commission has various articles on variable annuities too.

This Forbes article gives nine reasons why you need to avoid variable annuities:

MetLife has scaled back the sale of these policies, read this November 19, 2012 article from the San Francisco Chronicle:

And the Wall Street Journal chimed in with this May14, 2012 article:

New Taxes caused by Fiscal Cliff

Because of the inability of the two political parties to work together in Washington, President Obama signed into law the Budget Control Act in 2011 in order to raise the nation’s debt ceiling.  That law calls for an automatic cut of about a trillion dollars from the federal budget across the board over ten years.  This automatic cut, commonly known as “sequestration”, was never intended to take effect.  But since Washington is still in a gridlock, we are now faced with this fiscal cliff.

What the fiscal cliff will do on top of the spending cuts is to potentially raise taxes by more than $500 billion in 2013 – an average of almost $3,500 per household.  Much of it will come from the expiration of the so called “Bush tax cuts”.

Here is a partial list of the tax increases, not in any particular order:
  • The maximum capital gains will generally go up from 15% to 20%
  • Tax rate for qualified dividends will increase from 15% to the taxpayer’s highest marginal tax bracket
  • The lowest tax bracket will rise from 10% to 15%
  • The highest tax bracket will go from 35% to 39.6%
  • Employees’ portion of social security tax rate will go up from 4.2% to 6.2%
  • Teachers will lose their $250 deduction for non-reimbursed classroom supplies
  • Higher education tuition will no longer be deductible against gross income
  • The American Opportunity tax credit for higher education will expire and the Hope tax credit will return
  • Maximum annual contribution to a child’s education IRA will decrease from $2,000 to $500
  • Child tax credit will drop to $500 from the current $1,000 per qualified child
  • Maximum dependent care expenses allowed will decrease from $3,000 to $2,400 per child for up to two children
  • Marriage penalties will be re-introduced for lower tax brackets
  • Phase out of itemized deductions and personal exemptions will return
  • Exemption for alternative minimum tax (AMT) will drop dramatically, from $74,450 in 2011 to $45,000 in 2012 for married couples and from $48,450 in 2011 to $33,750 in 2012 for singles
  • Taxpayers age 70½ or older can no longer give money directly to charities from their IRAs and deduct the donation against gross income on page 1 of Form 1040
  • §179 deduction for businesses will drop from $500,000 to $139,000
  • Bonus depreciation will decrease from 100% to 50%
  • Certain incentives for employees to take public transit will expire
  • Homeowners with cancelled mortgage debt will face higher hurdles to exclude the forgiven amount from income
  • Mortgage insurance premium will no longer be tax deductible
  • No more deduction for sales tax in lieu of state income tax
  • Lifetime exemption will drop from $5,120,000 to $1,000,000

Sunday, November 18, 2012

How the Fiscal Cliff May Affect Your Taxes

See also

Potential 2013 tax rates:
By Kay Bell |

In a few weeks, tax laws U.S. taxpayers have enjoyed for more than a decade are scheduled to expire. Along with long-standing and historically low tax rates, several popular tax credits and deductions already have or will soon expire.

That scenario is being described as a fiscal cliff. And if American taxpayers are nudged over that cliff by Congressional inaction, most of them will face dramatically higher tax bills.

Estimates by tax policy groups and government accountants put the total tax cost at more than $500 billion in 2013.

That averages out to almost $3,500 per household, according to calculations by the Tax Policy Center. Middle-class taxpayers are likely to see an average increase of almost $2,000.

Using Tax Policy Center data and hypothetical taxpayers, Bankrate shows what some tax bills might look like if lawmakers don't soon put up a guardrail at the fiscal cliff's edge.

The single tax filer

Joe is single and has an adjusted gross income of $60,000 a year. As is the case among two-thirds of the tax-paying population, Joe claims the standard deduction.

After subtracting the projected 2013 personal exemption of $3,850 and standard deduction of $6,050 for a single taxpayer, Joe's taxable income comes to $50,100.

If the current tax laws are extended beyond 2012, that would mean $8,900 of Joe's income would be taxed at only 10 percent, and his top tax rate would be 25 percent. This would leave him with a tax liability of $8,465.

If the current rates expire, however, Joe's tax bill would be $863.50 higher.

The reason? There would no longer be a 10 percent rate, making more of Joe's earnings taxed at 15 percent, and his top tax rate would be 28 percent instead of 25 percent.

Married couple filing jointly

Jane and Bill have two kids: 10-year-old Jimmy and 8-year-old Sarah. Both parents work, bringing home a combined adjusted gross income of $175,000. They don't yet own a home, so without mortgage interest to deduct, they're still claiming the standard deduction.

If the current tax laws stay in place, their four personal exemptions totaling $15,400 plus the $12,100 standard deduction will get them to $147,500 in taxable income, resulting in a tax liability of $28,803.

But Jane and Bill wouldn't have to send the Internal Revenue Service that much. Thanks to the $1,000 per-child tax credit, their final tax bill would be $26,803.

If the tax laws expire, however, Jane and Bill's tax bill will go up by $6,304 to $33,107. That takes into account that the child tax credit would return to its pre-tax-cut level of just $500 per kid.

One reason for the increased tax bill is the return of the marriage tax penalty. This is where a couple pays more taxes by filing one joint return than they would if they filed two returns as single taxpayers. Wider tax brackets and a larger standard deduction for married couples now help ease the penalty.

Instead of facing a top tax rate of 28 percent, Jane and Bill would be in the 31 percent tax bracket if the tax cuts expire.

Single parent head of household

Kathryn is a divorced working mom of 7-year-old Jonah. She makes $75,000 a year via her salary and alimony payments.

By filing as head of household, Kathryn's standard deduction of $8,900 and personal exemptions totaling $7,700 for herself and her son get her to $58,400 in taxable income.

Taxes on that amount are currently collected at the 10 percent, 15 percent and 25 percent rates, giving Kathryn a tax bill of $9,125. She knocks $1,000 off that thanks to the child tax credit.

But if the tax cuts expire, Kathryn's tax liability will be $1,435 more -- $9,560 -- in 2013. The bigger bill comes from losing the expired 10 percent and 25 percent tax rates, putting more of her income into the 15 percent and 28 percent tax brackets.

And just like all parents, married or single, Kathryn will only get a $500 child tax credit for her son starting in 2013.

Expiration of capital gains rates

If any of our hypothetical 2013 taxpayers have investments in a taxable brokerage account, their tax bills next year will be higher.

Long-term capital gains and certain dividend payments are taxed at lower rates than the regular, ordinary income rates, which now top out at 35 percent. Most taxpayers pay capital gains taxes at the 15 percent rate. Taxpayers in the 10 percent and 15 percent brackets don't owe any taxes on their gains.

But if today 's lower rates expire, the capital gains rates will go to 20 percent for most investors and 10 percent for those in the 15 percent tax bracket.

And dividends will lose their favorable tax treatment entirely. These payments will return to being taxed as ordinary income, meaning that taxpayers making enough to put them into the highest income tax bracket in 2013 would pay taxes on dividends at the top 39.6 percent income tax rate.

In addition, a provision in the health care reform law, often referred to as Obamacare, will kick in next year. This new 3.8 percent surtax will apply to capital gains, dividend and interest income of more than $250,000 for married couples filing jointly or $200,000 for other taxpayers.

Payroll tax holiday over

Every person who collects a paycheck knows that taxes reduce take-home pay.

In addition to income taxes, both federal and where applicable state, payments toward Social Security and Medicare, known as FICA taxes, are collected via withholding.

So that workers would have more money to spend and give the economy a boost, Congress enacted a 2 percent cut in the Social Security taxes paid by workers. This so-called payroll tax holiday has been in effect since 2011 but is scheduled to expire Jan. 1, 2013.

That means every worker will pay more taxes in 2013. The increase could be substantial for high-income earners.

Individuals who make up to the Social Security wage base of $113,700 next year will pay $7,049.40 in taxes for the retirement system. That's $2,425 more than this year because the wage base was slightly smaller ($110,100), and workers paid just 4.2 percent of their income toward Social Security instead of the regular 6.2 percent level that returns in 2013.

Other expiring tax breaks

While the possibility of higher tax rates gets most of the attention as taxpayers near the fiscal cliff, many other provisions could cause higher taxes if they are allowed to end Jan. 1, 2013.

In addition to losing half of the current child tax credit, parents would get reduced savings from the child care tax credit.

Students looking for the $2,500 American opportunity education tax credit would find instead its predecessor the Hope credit, which maxes out at $1,800.

Lower paid workers could still claim the earned income tax credit, but eligibility requirements would be tougher and credit amounts lower.

The estate tax would apply to more property left at death, affecting estates worth more than $1 million instead of the current $5.12 million exclusion amount. The tax rate also would rise from the current 35 percent to 55 percent.

Higher-income taxpayers who itemize would again see their overall Schedule A claims reduced by 3 percent. A similar reduction also would apply to personal exemption amounts for wealthier filers.

And legislation to increase the alternative minimum tax income exclusion amount must be approved retroactively for 2012 as well as for 2013, or tens of millions more taxpayers will face higher tax bills because of this parallel tax.

Wednesday, November 14, 2012

IRS Warns AMT Could Affect 60 Million Taxpayers Unless Patched
Washington, D.C. (November 13, 2012)
By Michael Cohn
The head of the Internal Revenue Service told lawmakers that if Congress fails to extend the traditional patch for the Alternative Minimum Tax, approximately 60 million Americans could be affected and about 33 million taxpayers could pay the AMT for tax year 2012.

In a letter to the leaders of the tax-writing House Ways and Means Committee and the Senate Finance Committee, Acting Commissioner Steven T. Miller also warned that tax season could be delayed for up to a month next year if Congress does not act soon.

“A number of other tax provisions affecting individuals also expired at the end of 2011,” he wrote. “These include tax deductions for educators' out-of-pocket classroom expenses, tuition and related fees for higher education, and state and local sales taxes. The last provision is of particular importance to taxpayers in states with no income tax.

"These tax law changes are generally not as complex and do not present anything near the operational risk associated with the AMT patch," Miller added. "Two years ago, Congress enacted legislation extending these provisions retroactively in mid-December 2010. As a result, the IRS made the necessary changes to its forms and systems, and delayed the opening of the 2011 filing season by four weeks for approximately 9 million affected taxpayers. If the IRS were presented with a similar scenario of late enactment of tax extenders legislation this year, I would anticipate a similar outcome. There would be some inconvenience and delayed refunds for a substantial number of taxpayers, but the overall risk to the tax filing season would be manageable.”

Congress has returned to session this week after the elections with taxes among the top items on its agenda. The so-called “fiscal cliff” is looming with the expiration of the Bush-era tax rates and dozens of other traditional “tax extenders” at the end of the year, along with the prospect of automatic cuts in both defense spending and discretionary spending unless Congress and the Obama administration can agree on a deficit reduction plan. The nation is also once again approaching its borrowing limit and Congress will soon need to agree to raise the debt ceiling.

Miller noted that the expiring tax provisions have added uncertainty for next tax season. “This year has been particularly challenging due to several unresolved tax issues,” he wrote. “When Congress takes action well after this planning process is underway, there is potential for substantial disruption to the filing season ahead. As Congress returns this week, I wanted to provide you with a detailed description of the effects on IRS operational planning if the current uncertainty regarding the AMT and extenders continues.”

Miller noted that the AMT applies to individual taxpayers with incomes above specific thresholds set by law, but for many years, Congress has been enacting "patches" to index these income thresholds for inflation in order to prevent millions of taxpayers from being subject to the AMT. The last such patch expired on Dec. 31, 2011.

“More specifically, for tax year 2011, the AMT exemption amount (as indexed for inflation) was $48,450 for individuals and $74,450 for married taxpayers filing jointly,” he explained. “Because of these thresholds, only about 4 million taxpayers paid AMT for tax year 2011. Under current law, however, the thresholds revert to much lower levels for 2012—$33,750 for individuals and $45,000 for married taxpayers filing jointly. At these levels, approximately 33 million taxpayers would pay AMT for tax year 2012 (with returns filed in the spring of 2013). This is about 28 million more taxpayers who would pay the AMT than if the exemption amounts were increased as in the past.”

Miller also pointed out that the AMT patch has historically been accompanied by a special tax credit ordering rule that applies to all taxpayers claiming certain tax credits, whether they owe the AMT or not. “The ordering rules change the order in which a number of popular tax credits are applied against tax liability, and how they may be used to offset both regular and alternative minimum tax,” he explained. “Taken together, the changes to the AMT exemption amount and the special tax credit ordering rules could affect more than 60 million taxpayers—nearly half of all individual income tax filers. In addition, the changes to the tax credit ordering rules that result from a lapse in the AMT patch are highly complex and cut deeply into the core tax processing logic of IRS's critical filing season technology systems.”

In prior years—most recently in 2007 and 2010—Congress allowed the AMT patch to lapse for more than 11 months, but then retroactively reinstated it, Miller observed. “In both 2007 and 2010, the IRS consulted with Congress and was provided with bipartisan, bicameral assurances that Congress was working expeditiously to enact a patch. The IRS, in turn, made a risk-based decision to leave its systems programmed assuming that Congress would continue its historical practice and again enact extensions of both the increased AMT exemption amount and the special tax credit ordering rules.”

To stay consistent with past practice, Miller said he has instructed the IRS staff again this year to leave its core systems "as-is" with respect to the AMT, and hold off on the substantial design and engineering work that would be required in order to revert the core tax systems back to 1998 law, which will otherwise apply for 2012 in the absence of any action by Congress. “Therefore, if Congress enacts an AMT patch, including both increased exemption amounts and the special tax credit ordering rules, before the end of the 2012 calendar year, the IRS would likely be able to open the 2013 tax filing season with minimal delays for most taxpayers,” he said. “However, if there is no AMT patch enacted by the end of the year, the IRS would be forced to operate the 2013 tax filing season based on the expiration of the AMT patch. There would be serious repercussions for taxpayers.”

Without an AMT patch, Miller noted, about 28 million taxpayers would be faced with a very large, unexpected tax liability for the current tax year (2012). “In addition, in order to allow time for the IRS to make the programming changes necessary to conform our processing systems to reflect expiration of the AMT patch and the credit ordering rules, the IRS would, at minimum, need to instruct more than 60 million taxpayers that they may not file their tax returns or receive a refund until the IRS completes the necessary systems changes,” he added.” Because of the magnitude and complexity of the changes, it is entirely possible that these taxpayers would not be able to file until late March 2013, if not even later. Tens of millions of these taxpayers would unexpectedly have to pay additional income tax for 2012, leaving them with a balance due return or a much smaller refund than expected.

For millions of other taxpayers, refunds would be delayed.

“Finally, because the AMT patch already expired at the end of 2011, there is no ability to consider partial year extensions of the AMT (since by the end of 2012 it would have already lapsed for an entire year),” he noted.

Lawmakers greeted the news with dismay. “Congress must act now to address our unfinished business and give middle-class families certainty by extending this expiring relief,” said Ways and Means ranking member Sander Levin, D-Mich., in a statement.  “Just as there is no reason not to extend the middle class tax cuts immediately, there is no reason Congress does not act on a bipartisan basis as it has in the past to fix the AMT. The consequences of inaction would be enormous for millions of middle class taxpayers. Extending AMT relief will prevent a substantial and unexpected tax increase on millions of Americans.”

Wednesday, November 7, 2012

Retroactive tax increase passes with passage of Prop 30

Proposition 30 retroactively increases income taxes effective January 1, 2012. The measure creates three new personal income tax brackets for rich residents and adds a quarter-cent to the sales tax. The higher tax rates, which hit single filers making $250,000 and up and married taxpayers earning at least $500,000, last for seven years, and push the top tax rate to 12.3% for filers earning $500,000 and above, or $1 million per couple.

Proposition 30 also increases the state sales tax rate by 0.25% for four years, beginning January 1, 2013, bringing the standard statewide rate to 7.50% (currently 7.25%)..
Governor's Ballot Initiative
10.3% (1% increase) on income of: $250,001–$300,000 for single/MFS;
$340,001–$408,000 for HOH; and
$500,001–$600,000 for MFJ.
11.3% (2% increase) on income of: $300,001–$500,000 for single/MFS;
$408,001–$680,000 for HOH; and
$600,001–$1,000,000 for MFJ.
12.3% (3% increase) on income of: More than $500,000 for single/MFS;
More than $680,000 for HOH; and
More than $1,000,000 for MFJ.
(Note: Income in excess of $1 million is also subject to the 1% mental health surcharge.)

Affordable Care Act Changes in 2013

The Affordable Care Act was enacted on March 23, 2010 and includes the following important tax provisions that take effect in 2013.

Increased tax for high-earning workers and self-employed
The Medicare payroll tax is the main source of financing for Medicare’s hospital insurance trust fund. This fund is responsible for paying the medical expenses for beneficiaries who are age 65 and older or disabled. Under current law, wages are subject to a 2.9% Medicare payroll tax with workers and employers each responsible for half or 1.45%. Self-employed individuals pay both halves or 2.9%. The Medicare tax is levied on all wages or earned income without limit.

Under the new law, there will be an additional .9% hospital insurance tax (2.35% in total) that will apply to wages received in excess of $250,000 for married filing joint; $125,000 for married filing separate; and $200,000 for other filing statuses. This additional .9% tax applies to the employee’s portion of the Medicare payroll tax and is collected by the employer for wages in excess of $200,000. Self-employed individuals are also responsible for the additional .9% hospital insurance tax.

Surtax on unearned income of higher-income individuals
Currently, the Medicare payroll tax only applies to wages or earned income. Under the new law, the Medicare tax will also apply to investment income of individuals, estates and trusts. The surtax is set at 3.8% of the lesser of: 1) the taxpayer’s net investment income; or 2) the excess of modified adjusted income over $250,000 for married filing joint or qualified widow, $125,000 for married filing separate, and $200,000 for other filing statuses. For example, if a married couple earns $200,000 in wages and $100,000 in capital gains, $50,000 will be subject to the new surtax.

Net investment income includes interest, dividends, royalties, rents, gross income from passive activities and the net gain from disposition of property (other than trade or business). Investment income is reduced by any allocable investment deductions. Income from tax-deferred retirement accounts (401(k) plans) or excluded items (interest on tax-exempt bonds) is not included in the definition.

Higher threshold for deducting medical expenses
Currently, taxpayers can take an itemized deduction for unreimbursed medical expenses only to the extent that expenses exceed 7.5% of the taxpayer’s adjusted gross income. Under the new law, the AGI floor is raised from 7.5% to 10%. The AGI floor for individuals age 65 and older remains at 7.5% through 2016, then it is increased to 10%.

Dollar cap on contributions to health FSAs
A Flexible Spending Arrangement (FSA) is an tax favored account and is established through an employer’s cafeteria plan. Under an FSA, an employee can set aside a portion of earnings to pay for expenses, such as medical, dependent care or other expenses, as established in the cafeteria plan. Currently, there is no limit on contributions to health FSAs. Under the new law, allowable contributions to health FSAs will capped at $2,500 per year and indexed for inflation after 2013.

Deduction eliminated for retiree drug coverage
A sponsor of a retiree prescription drug plan is eligible for subsidy payments received from the Health and Human Services department. The subsidy is equal to a portion of the retiree’s gross covered prescription drug costs. Subsidies are excludable from the taxpayer’s gross income.

Under current law, a taxpayer may claim a business deduction for any covered retiree prescription drug expenses. Under the new law, amounts otherwise allowable as a deduction for retiree prescription drug expenses must be reduced by the excludable subsidy payments received. In effect, this provision eliminates the double benefit the taxpayer may receive.

Tuesday, November 6, 2012

2013 SDI rate released

The EDD has announced the 2013 SDI rate and wage base:
SDI rate Maximum wage base Maximum payment 
2013 1.0% $100,880 $1,008.80
2012 1.0% $95,585 $955.85