What is in the new Tax Relief Act passed by Congress?

We finally got a new tax bill and now everybody wants to know what’s in it. I’m still working on digesting it myself, but if you want to get ahead of the curve, I recommend taking a look at the Senate Finance Committee’s Summary which can be found here.

The major tax provisions are as follows:

  • The income tax rate increases to 39.6% (up from 35%) for individuals making more than $400,000 a year ($450,000 for joint filers; $425,000 for heads of household);
  • Dividends and capital gains are taxed at 20% (up from 15%) for individuals making at least $400,000 ($450,000 for joint returns);
  • The Personal Exemption Phaseout (PEP), which had previously been suspended, is reinstated with a starting threshold of $300,000 for joint filers and a surviving spouse, $275,000 for heads of household, $250,000 for single filers, and $150,000 (one-half of  the otherwise applicable amount for joint filers) for married taxpayers filing separately. Under the phaseout, the total amount of exemptions that can be claimed by a taxpayer subject to the limitation  is reduced by 2% for each $2,500 (or portion thereof)  by which the taxpayer’s adjusted gross income (AGI) exceeds the applicable threshold;
  • The “Pease“ limitation on deductions, which had previously been suspended, is reinstated with a threshold of $300,000 for joint filers and a surviving spouse, $275,000 for heads of household, $250,000 for single filers, and $150,000 (one-half of the  otherwise applicable amount for joint filers) for married taxpayers filing separately. Thus, for taxpayers subject to the “Pease” limitation, the total amount of their itemized deductions is reduced by 3%  of the amount by which the taxpayer’s AGI exceeds  the threshold amount, with the reduction not to exceed 80% of the otherwise allowable itemized deductions;
  • For estate, gift, and generation-skipping transfer (GST) tax purposes, for individuals dying and gifts made after 2012, there is a $5 million exemption (adjusted for inflation), and the top estate, gift and GST rate is permanently increased from 35% to 40%;
  • Tax credits for businesses, including the Code Sec.  41 research credit and the  Code Sec.  199 domestic production activities deduction, are generally extended through the end of 2013;
  • A number of individual tax provisions have been retroactively extended through 2013. In addition, there is a five-year extension of credits that were enhanced as part of the stimulus, including the college tuition credit, the Code Sec.  32 earned income tax  credit, and the Code Sec.  24 child  tax credit;
  • The two-percentage-point reduction in payroll taxes for Old Age, Survivors and Disability Insurance (OASDI) tax, commonly known as the Social Security tax, will be allowed to expire;
  • The higher exemption amounts for alternative minimum tax (AMT)—the so-called “patch”—are made permanent, resulting an estimated 30 million taxpayers escaping being subject to the AMT;
  • Various energy credits are also extended.

Other nontax provisions in the bill include a “doc fix,” which stops a 27% reduction in payments to Medicare doctors scheduled to go into effect. Spending cuts as offsets to accomplish this. Unemployment benefits, which were set to expire at the end  of 2012, are extended for the long-term unemployed through the end of 2013.

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Do you think we’re going over the “fiscal cliff”?

Apparently in response to my post yesterday, I received a couple of questions from people as to whether or not I think Congress will let us go over the “fiscal cliff.” First let me say that I really do not believe the “fiscal cliff” is anywhere near as dire as media would lead you to believe. Going over the cliff (and the lead up to it) is a huge pain to planners and other professionals like myself because there are a myriad of end-of-year decisions that need to be made by businesses and individuals and it’s impossible to make those decisions without knowing the tax consequences. The only way the tax consequences can be determined is by knowing what the rules are going to be beginning January 1, 2013, and as of today, it’s very uncertain what those rules will be. But to the vast majority of people who aren’t facing those end-of-year decisions, the December 31, 2012, “fiscal cliff” is simply not what it has been made out to be and Congress knows it.

So to the original question of “Are we going over the cliff,” I say yes, more than likely. Speaker Boehner seems to be trying to send through a “test vote” with his recent “Plan B,” and we should get the results of that vote later today. The “test vote” on “Plan B” appears to be nothing more than an effort by Boehner to see who he can count on in the House when the time comes to pass the compromise legislation. If Boehner can get enough votes in support of his “Plan B” measure, he can take that to President Obama and finally get the spending cuts he needs to put a more serious bill before the House. So the vote on “Plan B” today is key to determining whether will go over cliff. The Senate is on recess until December 27 so assuming Boehner can indeed rally enough support for “Plan B,” then presumably, a second bill that would be the true compromise legislation would likely be voted on by the House sometime early next week, with the Senate holding their vote towards the latter part of the week when they return to Washington. However, if Boehner can’t garner enough support on the vote this afternoon, a leap over the cliff is all but certain.

However, I wouldn’t overly worry yourself about going over the cliff because sometime next year (hopefully in January, but perhaps in December 2013 if the estate tax bill we got in 2010 is any indication), we will get the bill we’ve all been waiting for, and it will very likely be made retroactive to January 1, 2013, erasing almost all of the tax consequences of having gone over the cliff. That’s not to say there won’t be significant changes in the tax structure from 2012 to 2013, but December 31, 2012, is not quite the “cliff” that it’s been made out to be.

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What happens if we go over the “fiscal cliff”?

The American Institute of CPAs has released a Fiscal Cliff Series that provides a brief, objective  and non-partisan fact sheet on each of the following tax topics:

Each fact sheet describes the tax provision in question, explains what will happen if we go off the fiscal cliff, identifies who will be affected by the cliff, discusses whether the provision can be dealt with after January 1, and provides an AICPA comment and additional resources.

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What documents do I need to set up an LLC for my new business?

I have been asked this question numerous times and my initial answer is always a series of questions right back to the person asking me:

  • Why are you setting up an LLC for your business?
  • How did you determine you need an LLC?
  • Will you have partners?
  • Will you have employees?
  • What type of business are you forming?
  • Will this be an operating business that will sell goods or provide services?
  • What are you trying to accomplish by forming an LLC?
  • Is there a possibility the business could expose you to any liabilities?
  • What else do you own?
  • Do you know whether the business is subject to any special licensing?

There are actually many more questions that I commonly ask and the conversation usually takes 30-45 minutes and almost always exposes several things even the most business savy person hasn’t thought about. In truth, forming an LLC is really easy, but determining whether the LLC is the correct entity and then forming the LLC correctly is not quite as simple. The questions above and many more should be discussed with a business attorney who understands how the answers can effect your business and you as the owner of your business.

But I won’t cheat you out of the answer to your question, if after the discussion above you still want to go it on your own, my recommendation for the documents you need to form an LLC in the State of Mississippi is as follows:

  1. Certificate of Formation to be filed with the Mississippi Secretary of State along with the appropriate filing fee.
  2. Operating Agreement to set out the “rules” of your business.
  3. Form SS-4 to apply for a federal Employer Identification Number for your business.
  4. Mississippi Sales Tax Permit if your business will be conducting sales.
  5. Any other licenses, permits, etc. that may be particular to your type of business.

Links to all of the forms above can be found on the Mississippi Business Formation page of The Lynch Law Firm website.

 

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What is a “living will” and why do I need one?

I’m cheating a little bit this morning and writing a blog on a question I didn’t actually receive from someone, but I ran across an excellent article in the Wall Street Journal discussing the uses and limitations of living wills that I felt like needed to be shared with you. Let’s first make it clear that a living will, advance health-care directive, and durable power of attorney for health-care decisions all refer to the same document. These are the three common names for what I’ll call the “living will” today, but they all refer to a document that nominates an agent to make health-care decisions on your behalf in the event you are unable to make them for yourself.

As the WSJ article discusses, living wills are actually severely limited. Most living wills, including the one authorized Mississippi Code Section 41-41-209, simply nominate a person to make health-care decisions on your behalf in the event you are unable to make those decisions for yourself, but they do very little to advise your agent what your desires are should he or she ever have to make health-care decisions for you. Unfortunately, the statutory living wills such as the one in the Mississippi Code are often left too vague or only give direction where the outcomes are absolute. Very rarely do doctors simply say that a person has no chance of recovery after a stroke or some other severely debilitating condition. More often than not a doctor will instead give you “the chances,” such as advising a daughter that her father only has a “10-20% chance of having full brain function” should he ever wake up from a coma.

As an estate planner, I’ve found that while my clients trust their designated health-care agent to make the best decisions he or she can for them, they want more ability to advise their agent what he or she should consider when making those decisions. Again, the statutory living wills don’t provide for that flexibility so it’s necessary for clients and their planners to come up with other methods to make sure a designated health-care agent is prepared to make crucial health-care decisions. In order to help my clients better understand the issues and facilitate those important discussions, I recommend the Consumer’s Toolkit for Health Care Advance Planning provided by the American Bar Association. When used with the Toolkit, a living will becomes the document that clients want it be by providing their designated agent not only the authority to act on their behalf, but also the direction to make the decisions that their loved ones would have made if they were able to act for themselves.

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I am about to sell my home for less than I owe on my mortgage and the bank has agreed to take the loss. Are there any tax consequences?

This is actually a very important issue this year because of a change in the tax laws that’s due to occur at the end of the year that will result in a loss of big tax savings on January 1, 2013, and beyond.

Generally, when a person receives a cancellation of his debt, he is treated as having taxable income in the amount of the cancelled debt. For example, if you owe a bank $20,000 on a line of credit you took out for your business, your business subsequently is unable to repay the loan, and the bank agrees to forgive the loan, then you are treated as having $20,000 of taxable income.

The same is generally true for home loans. For example, assume that when you purchased your home, you received a $250,000 mortgage from Local Bank to assist with the purchase. Now assume that it’s 10 years later and as a result of a down economy and a few home equity lines of credit you took out on your home, you currently owe Local Bank $260,000, while your home is only worth $220,000. If you were to sell your home today, you would still owe Local Bank $40,000. Depending on the loan terms and on the bank, Local Bank could forgive the $40,000 shortfall. However, even if Local Bank decides to forgive the remaining balance of the loan, the IRS would generally require that you treat that $40,000 as taxable income!

Fortunately, when the real estate market began to crash back in 2007, Congress saw the problem on the horizon and decided to do something about it. Congress passed legislation to allow homeowners to exclude from taxable income any mortgage debt written off by their lenders in a loan modification or short sale. This means that as long as the mortgage was on the personal dwelling of the taxpayer, the taxpayer in our example above would not have to include the $40,000 in his taxable income.

Unfortunately, the exclusion provided by Congress will end on December 31, 2012. As a result, any loan modifications or short sales that occur on or after January 1, 2013, will again require the homeowner to recognize any loan forgiveness as taxable income.

In summary, if you are considering trying to pursue a loan modification or short sale for your home, you should make sure to do so by the end of this year. Waiting even just one extra day could result in a huge tax burden.

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What is a “living trust” and do I need one?

This is a question I get pretty regularly and one that I think really deserves some background explanation before answering.

First of all, when someone asks me if they need a “living trust,” I’m never quite sure if they are asking about a device similar to a will that would function to pass their belongings on to their loved ones, or if they are referring to an instrument that is used to help make medical decisions (commonly referred to as a “living will” or “advance health-care directive”). I’ve heard the term used for both purposes, but as an estate planner, the term “living trust” means an instrument that is created during your life (as opposed to at your death) that holds the legal title to your property and is often used to pass on your belongings to your loved ones at your death.

Estate planners often set up living trusts for their clients because probate can be avoided by setting up a living trust and transferring all of your property to it. Probate can be an expensive, time-consuming process (usually a minimum of 6 months) that an estate must go through in order to pass title from a deceased person to his or her heirs. I like to describe the probate process to my clients as follows:

Let’s pretend you own a nice house out in the country where you like to vacation on the weekends. At some point in the future, barring some kind of spectacular discoveries in medicine, you will die, and those of us left behind will need to figure out who’s going to own your country home after your death.

The first place we’re going to look to see who should be the next owner will be the warranty deed you received when you purchased your home. If you happened to have owned the home with someone else as a “joint tenant with rights of survivorship,” then that person will now be the sole owner of your home. But if you are listed as the sole owner, we have to begin to look elsewhere to know what to do.

The second place we’re going to look is to see if you had a will. If you had a will drawn up before you passed, and it says you want to leave your house to your son, Bobby, and your daughter, Sally, then they are likely the ones who are supposed to receive your country home. Unfortunately though, Bobby and Sally must first take your will to the courthouse and prove to the court (1) that the will they have is indeed your will, (2) that the will says they should receive the house, and (3) that nobody else (especially creditors) have any other claims to your country home. This process is called a “testate probate” with ”testate” simply meaning you died with a will. The probate process is the only way for Bobby and Sally to receive good title to the property which is important to allow them to sell the property or purchase insurance or even be listed on the property tax records.

What if you don’t have a will? Well, again we have to go back to the courthouse and tell the judge you don’t have a will and let him determine who now owns your home. He’s going to ask us to tell him who all of your heirs are (spouse, children, siblings, parents, nieces and nephews, etc.) and who all of your creditors are, and then he’s going to look to the Mississippi Code to tell him who is supposed to inherit your property. This process is called an “intestate probate” with “intestate” simply meaning you died without a will. Again, this type of probate is the only way for your heirs to receive good title to your property.

So you’re asking what in the world all of this has to do with a living trust, right? Well, the reason we had to go through the probate process in the situations above is because you died as the sole owner of the property. If instead we had transferred your country house to a living trust before you died, then the trust becomes the owner of the house. Your death doesn’t mean anything because you are no longer the owner. The trust is the owner, and it can’t die unless and until we’re ready to terminate it.

When an estate planner drafts a living trust for their client, they often include provisions telling the trustee (who is the person who does the business of the trust) what to do with the property when you die. A trust is a legal entity that can pass property to other persons without court approval just like you and I can. Therefore, at your death, the trustee of your trust can give the property to your heirs without going through the expensive and time-consuming probate process!

Now that we have the background, we can begin to answer our question as to whether you need a living trust. A living trust is an excellent option for many people, but is not the best option for everybody. Even though trusts can save a lot of money and time over the long-term, they are more expensive and time-consuming to set up than just drafting a will would be. I do not often recommend a trust for clients who are still in the stage of their lives where they are still acquiring more assets that would require transfer to the trust. However, they are perfect for elderly individuals and couples who are pretty well-settled. On the other hand, there are numerous instances where a living trust is very appropriate for even a very young couple or inappropriate for an elderly individual so it’s always best to consult with an experienced estate planning attorney before making that decision.

 

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Hello Mississippi!

Welcome to My Mississippi Tax Lawyer! If you’ve ever had a question about any of the following:

  • Federal income taxes;
  • Mississippi income taxes;
  • Mississippi sales taxes;
  • IRS;
  • Mississippi Tax Commission (or the Mississippi Department of Revenue, whichever you prefer);
  • Wills, trusts, & estate planning;
  • LLCs, corporations, partnerships;
  • And most anything else you can think of tax, business, or estate planning related!

You can ask that question and get an answer from someone who spent 9 years getting 4 degrees (Bachelor of Accountancy, Master of Accountancy, Juris Doctor, and Master of Law in Taxation) and various certifications (Admitted to the Bar in the States of Alabama and Mississippi and also a Certified Public Accountant) and has also spent the last 4 years in the trenches seeing it all. That’s 13 years of top-notch experience that you get to tap into by just shooting me an email!!

Talk to you soon!

David

 

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