Friday, January 30, 2015

WHAT’S THE BUZZ, TELL ME WHAT’S A HAPPENNIN’


FYI, this will be the last BUZZ installment before my tax season hiatus.   

So you don’t suffer from BUZZ withdrawal while I am “away” I suggest you check with Joe Kristan’s daily Tax Roundup at THE ROTH AND COMPANY TAX UPDATE BLOG, and look for the weekly “In the Blogs” recap from Jim Stimpson at ACCOUNTING TODAY.

And while I will not be posting to TWTP during the tax season, my Tax Tips series will continue at Main Street.

* Fellow tax pros - if you have not already done so please check out the January “issue” of THE TAX PROFESSIONAL and PLEASE send me your comments on my editorials.

* Have you seen this week’s post at BOB’S BABBLINGS yet?  I talk about superheroes on Broadway.    

* MainStreet.com continues with my filing season Tax Tips – “What to Ask a Potential Tax Preparer Before You Start a Working Relationship

* Looking for a tax professional to prepare your 2014 returns? Start your search at FIND A TAX PROFESSIONAL.

* It was one of BO’s SOTU tax proposals that I did not talk about in my TWTP posts – and it was just as well.  The WALL STREET JOURNAL reports “Obama Drops Plan to Raise Taxes on ‘529’ College Savings Accounts” -

The Obama administration said it would drop a plan to tax so-called 529 college savings accounts, after the proposal sparked widespread criticism over its potential impact on the middle class.”

Anywho - it is all academic, as none of BO’s SOTU tax proposals will become law.

* Jason Dinesen tells us “What I’m Asking My Clients Regarding the ACA” at DINESEN TAX TIMES.

In “ACA Due-Diligence” from the January “issue” of THE TAX PROFESSIONAL I talk about this issue –

And I do not have to verify that a client has health insurance coverage.  I simply ask the client and he or she tells me yes or no.

If they tell me yes I do not need to do anything more.  Unless I have independent personal knowledge or information to the contrary I assume he or she has told me the truth.  To repeat I do not need to “verify” via independent documentation that the client does, in fact, actually have coverage.”

And-

In most cases I will know if a client had full-year insurance coverage without even asking the question – based on the forms, returns and information he normally gives me every year.”

* My post on an interesting, and unintended, way New Jersey screws retired residents is included in this weeks “In the Blogs” installment at ACCOUNTING TODAY titled “If You’ve Told Them Once …”.

* “In the Blogs led me to “Why Learning to Prepare Tax Returns by Hand is Crucial” by Charles McCabe at THE INCOME TAX SCHOOL blog -

While established tax preparers will be putting their tax software into overdrive this season, we’d like to take this opportunity to talk about the importance of NOT using tax software as a student learning to prepare taxes.”  

Great minds do think alike.  I have always said that the best way to learn how to prepare tax returns is to prepare tax returns – and by hand.

* Before I go – one more plug for my “Tax Professional Forms, Schedules, Worksheets, and Client Memos”.

THE FINAL WORD-

It looks like I am screwed.  A sign on the door of a library in suburban NJ said that it would not have many tax forms available during the season due to IRS budget cuts.

So I will have to get my 1040 an 1040A forms for clients online.

I remember the days, 40 years ago, when I would take a suitcase to an IRS warehouse in Newark NJ and fill it up with paper tax forms and schedules.

As other bloggers have observed – the IRS has cut customer service in response to the budget cuts. 

The notice on the library door said that if you are unhappy about the lack of tax forms you should write to your idiots (my word) in Congress – and it listed the addresses of the applicable idiots.

TTFN

Wednesday, January 28, 2015

OBAMACARE AND 2014 TAX RETURNS


In the course of researching my MainStreet.com Tax Tips on how Obamacare affects 2014 tax returns (which will be published in early February), and preparing my first 1040 involving the Premium Tax Credit, I have come across the following items of interest -

(1)  The Modified Adjusted Gross Income (MAGI) used to determine the individual shared responsibility penalty and calculate the Premium Tax Credit begins with Adjusted Gross Income and adds excluded foreign income from Form 2555 or 2555-EZ and tax-exempt income report on Line 8b of the 1040 or 1040A.  However when calculating the Premium Tax Credit you must also add any nontaxable Social Security benefits (including tier 1 Railroad Retirement benefits).

(2)  Because the calculation of the individual shared responsibility penalty and the Premium Tax Credit begins with AGI, you can reduce the penalty or increase the credit by making, or increasing, a deductible IRA or self-employed retirement plan contribution.

(3)  The IRS does not have the power to enforce the collection of the individual shared responsibility penalty.  There is no enforcement mechanism for collecting the individual shared responsibility penalty other than reducing a taxpayer’s current and future refunds.  The Affordable Care Act does not permit the IRS to levy or attach a lien to wages, bank accounts or personal assets to collect the penalty, and no criminal prosecution or penalty may be imposed on anyone for refusing to pay the penalty.
 
(4) The IRS has announced some penalty relief for returns that include a payback of excess advance premium credits.  Trish McIntire goes into detail in her post "Premium Tax Credit Penalties" at OUR TAXING TIMES. 

TTFN

Tuesday, January 27, 2015

WHAT’S THE BUZZ, TELL ME WHAT’S A HAPPENNIN’


* Check out the January “issue” of THE TAX PROFESSIONAL – the last word from TTP until after the tax filing season.   

And fellow tax pros, PLEASE send me your comments on my editorials.

* Did you see this week’s post at BOB’S BABBLINGS?    

* MainStreet.com continues with my filing season Tax Tips –



* Looking for a tax professional to prepare your 2014 returns? Start your search at FIND A TAX PROFESSIONAL.

* Words of wisdom from Trish McIntire in “Waiting Game” at OUR TAXING TIMES -

So no, I can’t use your last paystub to file your return. First, it’s illegal. Secondly, the paystub may not have all the info I need. Nor can I do a return based on your insistence that everything is the same as last year. Believe me, it never is. I need this year’s numbers.”

* Jason Dinesen talks about “Ridiculous IRS Situations I’ve Recently Dealt With” at DINESEN TAX TIMES.

Considering the IRS budget cuts it doesn’t look like things will b getting any better soon.

I expect the multiple “45 days” letters that we all get before the Service fixes its FUs will become “60 days”.

I, too, have noticed post-dated letters from the IRS.

However one thing can be sad for the IRS.  As Jason tells us (highlight is mine)–

Finally a few weeks ago, the IRS sent a letter saying they found the payment, it had accidentally been misapplied in their system, and apologizing for any inconvenience.”

This is not unusual – but those who deal with the NJ Division of Taxation know that receiving an apology from the Division is a true rarity.

* It looks like what I feared will probably happen.  INC reports “Treasury Secretary to Congress: Focus on Business Taxes, Not Income Taxes” –

Treasury Secretary Jacob Lew dismissed efforts in Congress to overhaul the nation's tax laws by lowering the top income tax rate paid by individuals, saying lawmakers should instead focus on simplifying taxes paid by businesses.”

I had given up on any substantive individual income tax reform happening during the remaining years of the BO presidency anyway.

* Jean Murray thinks “Using Cash to Pay Employees and Independent Contractors” is not a good idea, and explains why at ABOUT.COM.

* As tax filing season is almost here (it begins on February 1st), Robert W Wood reminds us of “10 Crazy Sounding Tax Deductions IRS Says Are Legit” at FORBES.COM.  Actually in most cases it was the Tax Court who said the deductions were legit.   

* RWW’s fellow FORBES.COM tax blogger Kelly Phillips Erb (aka Taxgirl) reports that you can now “Track Tax Refunds, Obtain Tax Transcripts This Filing Season With Free IRS App”.

* My discussions on BO’s SOTU tax proposals are referenced in ACCOUNTING TODAY’s weekly BUZZ-like “In the Blogs” series post titled “Fail, Caesar”.  

TTFN

Friday, January 23, 2015

WHAT’S THE BUZZ, TELL ME WHAT’S A HAPPENNIN’


A tax loophole is something that benefits the other guy. If it benefits you, it is tax reform” — Russell B. Long   

* Check out the January “issue” of THE TAX PROFESSIONAL – the last word from TTP until after the tax filing season.   

And fellow tax pros, PLEASE send me your comments on my editorials.

* Did you see this week’s post at BOB’S BABBLINGS yet?  Why not?  

* MainStreet.com continues with my filing season Tax Tips –




They were behind, but have been catching up this week.

* Jean Murray gives us the “7 Most-Asked Business Tax Questions – Answered” at ABOUT.COM.

I have a different answer to Jean’s #4 - “Do I need a CPA to prepare my business taxes?  The answer is a definite NO.  You do not NEED a CPA to prepare any income tax return.  You only NEED a CPA if you must submit audited or reviewed financial statements to a third party.

You may want to engage a particular CPA to prepare your business tax returns because of the ability of and other factors applicable to that particular CPA.  However you can also engage an EA (Enrolled Agent) or a Public Accountant (non-certified), or even an “unenrolled” tax preparer – again because of the ability of and other factors applicable to the specific EA, accountant, or preparer.

I also disagree with her statement – “A simple service business (no products) filing Schedule C can use a tax software program.”  No tax preparation software is a substitute for knowledge of the Tax Code.  And no tax preparation software is a substitute for a knowledgeable and experienced tax professional.  You should not trust something as important as your businss tax return to a “box”.

I do agree that “a corporation or complicated partnership probably needs a tax expert.”  But a CPA is not necessarily a “tax expert” – certainly not simply by virtue of possessing the initials “CPA”.  And there are plenty of other “tax experts” from which to choose, most less expensive (without sacrificing quality) than a CPA.

I could not find a way to submit the above as a “comment” to Jean’s post at ABOUT.COM.

* Is a puzzlement.  According to Kelly Phillips Erb, FORBES.COM’s TaxGirl, “Walmart Says 'Skip The Check' & Pick Up Tax Refunds In Cash” -

Customers can opt in to Direct2Cash using software or at specific tax preparation locations: there are more than 25,000 participating sites, including some in-store locations staffed by Jackson-Hewitt. . . .

After filing, customers will receive a confirmation code for their federal and/or state tax return via email (customers who file a federal and state tax return will get two confirmation codes). Customers will then go to the Walmart MoneyCenter or customer service desk at their local Walmart store, show their confirmation code, confirm their identity, and then receive their refund in cash. Walmart does not charge customers a fee when refunds are claimed in a store.”

KPE points out that –

This isn’t a RAL (refund anticipation loan). It’s not a loan at all. It’s more of a e-check/check cashing service all in one.”

I do not understand.  Just because a tax preparer like Jackson Hewitt says you are going to get a refund of $XXX does not mean that the IRS is going to send you a refund of $XXX.  And what happens to the actual refund check?  How can taxpayers get money that is not a loan before the amount has been verified and issued by the IRS.

Kelly – please explain further.

The fee, charged by the tax preparer, for this “convenience” will be at most $7.00.  However if you must use Jackson Hewitt to get the service it may cost you a lot more than $7.00 in the long run.

My advice – avoid this program.

* The website of the NJ Division of Taxation now announces - “The Division will begin mailing 2014 Property Tax Reimbursement applications to homeowners and mobile homeowners in mid-February”.

They are talking about the PTR-1 and PTR-2 forms.  The original deadline will probably be announced as June 1st, as it is every year.  But, again as it is every year, the deadline will eventually be pushed to October.

And, also as usual, the income threshold for 2013 (80,000+) will be reduced to $70,000 to balance the budget on June 30th.

Look for a post on the PTR program here at TWTP before I begin my tax-season hiatus.

* A good suggestion from Trish McIntire of OUR TAXING TIMES – “Savings Bonds from Refunds”.  

* Trish also discusses “myRA - A Retirement Alternative”.

This account was first discussed by BO in his 2014 State of the Union address – but it was soon forgotten.  Apparently, as Trish reports –

The Treasury Department has the program up and running now.”

This is something I need to do more research about myself.

* Michael Cohn reports at ACCOUNTING TODAY that “IRS Scammers Net $14 Million from 3,000 Victims” –

The pervasive IRS impersonation phone scam has claimed nearly 3,000 victims who have collectively paid over $14 million, according to a new warning from the Treasury Inspector General for Tax Administration.

As the 2015 tax filing season begins, TIGTA reminded taxpayers to beware of phone calls from individuals claiming to represent the IRS while intending to defraud them.”

Remember – the IRS will NEVER EVER make first contact by telephone.  And, as the item states –

The agency {IRS} will not ask for payment using a pre-paid debit card or wire transfer. IRS employees also will not ask for a credit card number over the phone.”

TTFN

Thursday, January 22, 2015

ONE WAY RETIREES ARE SCREWED ON THE NJ-1040


Here is an interesting, and unintended, way the State of New Jersey screws retired residents.

This is different from the way the NJ Division of Taxation screws taxpayers by remaining unethically silent upon receiving overpayments.

If your NJ Gross Income is not more than $100,000, and you are age 62 or older, you can exclude up to $15,000 ($20,000 for married filing joint and $10,000 for married filing separately) of the pension, annuity, and IRA income reported on Line 19a of the NJ-1040.

If you do not use the full $10,000, $15,000, or $20,000 toward pension, annuity, or income income – i.e. Line 19 is only $7,500 – you can claim the difference as an “Other Retirement Income Exclusion”.

You cannot claim any “Other Retirement Income Exclusion” is you have what the state considers “too much” earned income from wages or self-employment (sole-proprietor, partner, sub-S corporation shareholder) income.  In this case “too much” is $3,001.

The instructions tells us that one of the requirements for being able to claim this additional exclusion is –

Income from wages, net profits from business, distributive share of partnership income, and net pro rata share of S corporation income totaled $3,000 or less.”

Where a retiree gets screwed is when it comes to “distributive share of partnership income”. 

It is clear that the intention of the law was to use the $3,000 threshold for the distributive share of partnership self-employment income – the type of income equivalent to that reported on a federal Schedule C.  However the screwing occurs because of how “distributive share of partnership income” is reported on the NJ-1040.

On the federal return the different types of partnership income are passed through via the Form K-1 to Form 1040 based on the type or source of the income.  Interest and dividends are reported on Schedule B, capital gain income is reported on Schedule D, and self-employment business income is reported separately.

However on the NJ-1040 partnership income is reported as one category of income rather than in respective categories.  Interest, dividends, rents, gains, or losses earned by a partnership are now combined with Federal ordinary income (loss) to arrive at New Jersey partnership income (loss).

So the amount reported as “distributive share of partnership income” includes interest, dividends, royalties, capital gains, etc. as well as “business income”.  A special worksheet included in the NJ publication on partnership income is used to consolidate the federal K-1 entries into the one NJ-1040 entry if a NJ-K-1 is not issued.

Unfortunately, when investing money for retirees many brokers purchase, as an alternative to stock or mutual fund shares, units in limited partnership investments.  The result is truly a PITA for tax preparers.

Another result is that the income from the limited partnership investment, for the most part interest, dividends, and capital gains which are reported separately on the federal return, is combined to determine net “distributive share of partnership income” reported on the Form NJ-1040.

The instructions for the NJ-1040 do not indicate that excess business income from a partnership can eliminate any “Other Retirement Income Exclusion”.  It simply says “distributive share of partnership income”.

Here is an example of the screwing.

A 90+ year old taxpayer, retired with no “earned” income, does not have any taxable pension, annuity, or IRA income.  His total NJ taxable income comes from his investments – interest, dividends, capital gains, and investment income from limited partnership investments.  His NJ Gross Income is less than $100,000.  So you would think he could claim a $15,000 “Other Retirement Income Exclusion”.

But what if the total pass-through investment income generated by the investments in limited partnerships exceeds $3,000?  Under current NJGIT law this causes him to lose the $15,000 exclusion.  And $1.00 in partnership income can cause him to lose the $15,000 exclusion!  So he is royally screwed!

Actually the “net pro-rata share of S corporation income” can be true dividend-equivalent income – if the shareholder is a passive investor in the corporation.  Another case of retiree screwing.

Obviously the best way to avoid this screwing is to not invest in limited partnerships (something that would certainly make tax preparers very happy).  I firmly believe that a broker could find a stock or mutual fund investment that would provide the same potential for income and gain as any limited partnership.  But, (this is my personal opinion – and not necessary gospel) perhaps because the broker receives a better commission from selling limited partnership units, brokers do not look for an alternative and insist on buying LP units for clients.

It seems very clear to me that allowing investment income from a partnership to “exclude the exclusion” was not the intention of the idiots in Trenton when creating the “Other Retirement Income Exclusion”.  But because of the way partnership income is reported on the NJ-1040 it is what can happen.

I expect it would take legislation to fix this FU.

Tax pros – your thoughts?

TTFN

Wednesday, January 21, 2015

WHAT’S NEW FOR 2014 STATE TAX RETURNS?


The 2014 NJ state, and all of the 2014 NY state, forms and returns are now available at the websites of the respective tax agencies.  Click here for NJ and here for NY.

As I believe I said in a previous post, there appears to be no changes to the NY state forms – other than the fact that the standard deduction amounts have been adjusted for inflation and there is now a separate form for reporting addition and subtraction adjustments.

As for the NJ-1040 – the only things new for 2014 are the following -

(1) If you were a homeowner during 2014 you must now enter the Block and Lot, and, if applicable, Qualifier, Numbers, and the 4-digit “Municipal Code” (listed in the instruction book), for the property that you owned and occupied as your principal residence on December 31, 2014, along with the property taxes paid (not new), on the bottom of Page 2 of the NJ-1040.  If you were not a homeowner on December 31, enter the information for the last home you owned and occupied during the year.  If you were a tenant there is no need to make any entries on the new lines 37(b) and 37(c).

(2) If your paid preparer is required to file all returns electronically, but you want to file a paper return, you can “opt-out” of electronic filing by enclosing Form NJ-1040-O, E-File Opt-Out Request Form, with your paper return. Both you and your preparer must sign the form, and your preparer must fill in the oval above his or her signature on your return to indicate that Form NJ-1040-O is enclosed.

Since the only way I can submit NJ-1040s electronically is via the NJWebFile system, as I do not, and will never, use flawed and expensive tax preparation software, and there are a lot of restrictions that forbid me from using this system for many returns, I guess I will be signing a lot of NJ-1040-O forms this season.

I have taken a look at the eligibility requirements for using NJWebFile for 2014, and, with the exception of increasing the maximum number of W-2s you can report, it appears that most of the previous restrictions still remain.  Perhaps most important – you cannot use NJWebFile if you are claiming a credit for excess FLI insurance contributions.  Why, I have no idea.  I guess NJDOT is too cheap to pay to have someone fix the software.

I thought the Director had said that taxpayers could submit the “filled-in” 2014 Form NJ-1040 available at the NJDOT website “electronically” – but this is not discussed on the website.  I guess I will need to wait until actually preparing a 2014 NJ-1040 using the “filled-in” option to see if this can be done.

Something else new -

Paper copies of New Jersey Tax forms are not available at public sites such as libraries or post offices. Public libraries that offer computer access may allow patrons to download/print forms from this website.  Because all forms are available on this site and can be photocopied, multiple copies of any form will not be provided, regardless of whether the request is made by email, calling the Customer Service Center, or by visiting a Division of Taxation Regional Office.” 
 
I will let you know if there is anything else new for the 2014 NJ-1040 as, or if, more information becomes available. 

TTFN

WHAT’S THE BUZZ, TELL ME WHAT’S A HAPPENNIN’ – WEDNESDAY EDITION


A day late – but certainly not a dollar short!

* Check out the January “issue” of THE TAX PROFESSIONAL – the last word from TTP until after the tax filing season.   

And fellow tax pros, PLEASE send me your comments on my editorials.

* Over at BOB’S BABBLINGS I talk about movie remakes – more often than not a bad idea.

* Michael Cohn tells us “Average Tax Prep Fee Inches Up to $273” at ACCOUNTING TODAY -

The average fee for preparing a tax return, including an itemized Form 1040 with Schedule A and a state tax return, will increase a few dollars to $273 this year, a 4.6 percent increase over the average fee of $261 last year, according to a survey by the National Society of Accountants.”

And

The average cost to prepare a Form 1040 and state return this season without itemized deductions is expected to be $159, also a 4.6 percent increase over the average fee last year, which was $152.”

And, very important –

All the fees cited assume a taxpayer has gathered and organized all the necessary information. . . . Many tax preparers will charge an average fee of $114 for dealing with disorganized or incomplete files.”

I am going to include a copy of this article to my invoices this tax season so my clients can see just how very lucky they are.

* One more plea - please help to spread the word about my website FIND A TAX PROFESSIONAL.

* Taxpayer Advocate Nina Olsen recently released the required 2014 Annual Report to Congress.

Each year at this time The National Taxpayer Advocate delivers this report directly to the tax-writing committees in Congress (the House Committee on Ways and Means and the Senate Committee on Finance) with no prior review by the IRS Commissioner, the Secretary of the Treasury, or the Office of Management and Budget.

The report discusses the nation’s most serious tax problems and the most litigated tax issues and makes legislative recommendations.

Nina predicts that taxpayers this year are likely to receive the worst levels of taxpayer service since at least 2001. 

And, a recurring theme in Nina’s reports, the report urges Congress to enact comprehensive tax reform, pointing out that simplification would ease burdens on both taxpayers and the IRS.

#1 on the list of Most Serious Problems –

Taxpayer Service Has Reached Unacceptably Low Levels and Is Getting Worse, Creating Compliance Barriers and Significant Inconvenience for Millions of Taxpayers.”

And #6 –

Implementation of the Affordable Care Act May Unnecessarily Burden Taxpayers.”

And tax professionals and the IRS, too!

Click here to download the full report.

* Jason Dinesen continues his posting series on “A Brief History of Marriage in the Tax Code” with “Part 2: Taxes in 1913” at DINESEN TAX TIMES.

* Jean Murray answers a timely question at ABOUT.COM – “I Received a 1099-MISC form - What DoI Do With It?".

Pay special attention to her final item (highlights are mine) –

What if I have income but no 1099-misc form? Do I still have to pay taxes on this income?  All income must be reported to the IRS and taxes must be paid on all income. The payee may have forgotten to prepare and submit a 1099-MISC form for the income paid to you. Most likely, the payee may have not paid you $600 or more in a calendar year, in which case, no 1099-MISC must be filed. If you receive payments from several payees, you may or may not have a 1099-MISC form to match all payment, but you must still report and pay taxes on all 1099 income each year.”

* Tax filing season is almost here (don’t correct me – it starts on February 1st for me and always has) – so that means it is once again time for “Fun With Taxes: Tax Haiku 2015” over at Kelly Phillips Erb’s FORBES.COM TaxGirl blog.

I will work on my tax haikus when I come up for air.

THE FINAL WORD –

You now can file your 2014 tax returns – but that doesn’t mean you should file your 2014 taxes now. 

Wait until at least February 3rd to be sure you have all the information returns (W-2s, 1099s, 1098s, 1095s, K-1s, etc) needed to correctly prepare your returns.

TTFN

Tuesday, January 20, 2015

BO SOTU PLANS TO INCREASE TAX ON THE “WEALTHY”


Yesterday I told you what tax “reform” for the “middle class” that BO will be proposing in tonight’s State of the Union address.

Today I will tell you how he plans on having the “wealthy” pay for these expanded, and Code-complicating, tax expenditures.

Raise Top Capital Gains and Dividend Rates

BO wants to raise the top “special” tax rate on qualified dividends and long-term capital gains from 20% to 28%.

We are told that the current top tax rate on qualified dividends and long-term capital gains is 23.8% - 20% maximum capital gain tax rate plus the 3.8% Obamacare surtax on net investment income.  This is not true. 

For high income taxpayers who are victims of the dreaded Alternative Minimum Tax, especially those who live in highly taxed states like New Jersey, New York, and California, the effective tax cost of qualified dividends and long-term capital gains can be higher – almost 31%.   

While qualified dividends and long-term capital gains are also taxed separately, at the special capital gain rates, under the dreaded AMT, this income increases “Alternative Minimum Taxable Income”, and can decrease and eventually wipe out the AMT exemption amount – causing more “ordinary income” to be taxed at the AMT rate.

When I first started preparing 1040s, back in the early 1970s, there were no special “capital gains tax rates”.  However there was a 50% capital gain exclusion.  50% of all long-term capital gains disappeared from the tax return.  If your capital gain was $10,000 your Adjusted Gross Income and net taxable income was reduced by $5,000, and you basically paid tax, at regular ordinary income rates, on $5,000.  I think I prefer this concept to a special capital gains tax rate – although I will admit I very much like the current 0% tax rate.

I would gladly support doing away with a special reduced tax rate on dividends if, and only if, a “dividends paid deduction” was permitted for corporations.  I would also gladly support doing away with all special industry-based corporate tax “loopholes” – so that you were taxed on corporate book income less dividends paid. 

{Aside - I also support doing away with the corporate deduction for depreciation of real property – but that is the subject for another post.}

Eliminate Stepped-up Basis on Inherited Property

BO proposes to eliminate stepped up basis at death.  He calls the step-up in basis an “egregious” loophole, and “the single largest capital gains tax loophole”.  

When you inherit investments – stocks, mutual fund shares, real estate – your “tax basis” for reporting capital gain and loss on the sale of the investments inherited is the fair market value of the investments on the date of death of the person from whom you inherit the assets – or the fair market value 6 months after the date of death.  It is the value for the investments that would have been reported on the federal estate tax return if one had been filed.

If your uncle purchased 100 shares of XYZ corporation for $1,000 in the 1970s, and the stock is worth $11,000 when he leaves it to you, your “cost” is $11,000.  If you sell the stock once title has been transferred to your name for, say, $11,500 you have a taxable long-term capital gain of only $500.  If you sell the stock for $10,000 you have a $1,000 long-term capital loss.

{FYI - the sale of inherited property is always treated as long-term by the beneficiary regardless of when the deceased actually purchased the property or how long you held it before selling.}

Nobody pays any capital gains tax on the $10,000 increase in value (the stepped up basis) based on the original $1,000 purchase price.

Why does this happen?  To avoid double-taxation.  The $11,000 value of the stock would have been included on the federal Estate Tax Return of your uncle, and would have been taxed had there been a taxable Estate.

This was a lot more likely when the federal Estate Tax exclusion was $675,000 – but is truly rare today with the current $5+ Million exemption. 

If there was a taxable estate the Estate Tax on the $10,000 increase in value would be a lot more than the capital gains tax of 0%, 15%, 20%, or even 28%.

It appears to me (and correct me if I am wrong) that under BO’s proposal the capital gains tax on the increase in value would be assessed to and paid by the estate at the time of death.  The beneficiaries would still receive a “stepped up” basis (because the tax was already paid by the estate) and not have to pay the capital gains tax when they sell the property.

This would not affect the federal Estate Tax filing.  I expect the gain would be paid on a Form 1041, or perhaps a new 1041-CG, filed by the estate.  And the tax would be paid directly by the estate; the gain would not be passed through to the beneficiaries on a K-1.

It is unclear just how the appropriate capital gains tax rate – 0%, 15%, 20%, or even 28% -would be determined.  Perhaps it will be based on the deceased’s final 1040, or the last 1040 that covered a full calendar tax year.

Under this plan, if there is a federally taxable estate, say in the above example your uncle’s estate was worth $10 Million, there would still be a “double-taxation” on the increase in value.  Perhaps there would be an adjustment on the 1041-CG for capital gains that were taxed on the Form 706 (the Estate Tax return). 

As explained in “Obama Proposes New Tax Hikes on Wealthy to Aid Middle Class” by Richard Rubin and Margaret Talev at BLOOMBRG.COM –

The administration’s proposal on capital gains at death would exempt the first $200,000 in capital gains per couple plus $500,000 for a home {the current exclusion for gain on the sale of a personal residence on a joint return – rdf}, along with all personal property except for valuable art and collectibles. The rest would be treated for income-tax purposes as if it had been sold.”

And the proposal would also exempt inherited small, family-owned businesses from capital gains tax at death unless and until the business was sold. Any closely-held business subject to capital gains tax would have the option pay out over 15 years.

I have always been against totally eliminating the step-up in basis for inherited property.  It is one reason I have been somewhat hesitant to support “killing” the federal “death tax” (aka Estate Tax).  Eliminating the step-up in basis would create a nightmare for tax professionals.  It is hard enough to get clients to keep track of investments purchased during their lifetime, let alone what their parents or other relatives paid for property and investments acquired before they were born!   

This “loophole” benefits lower and middle income individuals just as much as it benefits the wealthy.

However, having the capital gains tax paid by the estate before transferring title to the beneficiaries is a better way of dealing with the taxes lost by stepped-up basis.  There would still be problems determining the cost basis, depending on when and how the investments were originally acquired by the deceased.  But a lot less problems than if we taxed the beneficiaries when they sell the investments.

If there is going to be an elimination of the stepped-up basis tax avoidance this is a better way to implement it.  It shows some actual thought by BO, or whoever actually came up with the plan, a true rarity when it comes to tax legislation.

Of course this is all academic.  BO’s tax proposals, both to help the middle class and punish the wealthy, will never pass in the Republican controlled Congress.

TTFN