Business and Corporate Section Monthly Article

Year 2014 Tax Update -Sorting out the Prior 2013 Law Changes and Bracing for the Possible Tax Law Changes in Late 2014.  

I.  Introduction - Overview. 

The tax year 2013 was an eventful year for federal income tax development as a result of: (i) the most important provisions under the 2010 Act (Affordable Care Act) including the Net Investment Income Tax (3.8%) and the Additional Medicare Tax (0.9%) becoming effective in 2013; and (ii) the passage of the 2012 Act (American Taxpayer Relief Act of 2012), which permanently extended the Bush-era tax cuts for all those but the higher income taxpayers.

For those of us who have timely filed our tax year 2013 tax returns, we understand that the 2010 Act and 2012 Act have changed the landscape for higher income taxpayers when compared to tax years before 2013.  In a nutshell, for the tax year 2014, and similar to 2013, those who make more than $200,000 (single) and $250,000 (joint) will pay more in taxes.

As of this time, Congress has not extended any of the 57 income tax provisions (individual and corporate) that expired on January 1, 2014, and which are generally extended.

Additionally, there are two leading tax proposals currently before Congress, including: (i) the House Ways & Means Chair Dave Camp proposal; and (ii) President Obama's 2015 Budget proposal.

The following provides some background regarding the most significant tax changes that have occurred in the last couple years and which first became effective in tax year 2013.  Such tax law changes will also affect our tax year 2014 taxes.

II. The Patient Protection and Affordable Care Act (the 2010 Act).

Enacted in March 2010, the 2010 Act (aka: Obama Care) imposes among other things, the mandate on individuals and large businesses to obtain health care.  Also, the following tax items became effective beginning in the tax year 2013:

  1. 3.8% Surtax on Net Investment Income (aka “3.8% Medicare Tax” or "Net Investment Income Tax" or "NII")A 3.8% tax applies to individuals, estates, and trusts on the lesser of: (a) “Net Investment Income;” or (b) the excess of “Modified Adjusted Gross Income” over $200,000 (single) / $250,000 (joint).  “Net investment income” generally includes passive unearned income (e.g., interests, dividends, annuities, royalties, rents, net gains (i.e., capital gains) from the sale of property).
  2. FICA Payroll Tax:  Employees and Self-Employed – 0.9% Surtax (or “0.9% Additional Medicare Tax”)For the tax year 2014, generally, a combined tax rate of 7.65% (6.2% for old-age, survivors, and disability insurance (Social Security) and 1.45% for hospital insurance (Medicare tax)) is imposed on each of the employer and employee (total equals 15.3%).  The 7.65% Social Security maxes out once the employees earnings for 2014 hit $117,000Additional Medicare tax of 0.9% (on top of the 1.45%), however, is applicable on earned income above $200,000 (single) / $250,000 (joint).  The additional 0.9% Medicare tax applies to both wages (employee’s share only) and net self-employment income.

III.  The American Taxpayer Relief Act of 2012

Was signed into law by President Obama on January 2, 2013 (the 2012 Act).  The 2012 Act centered on a partial resolution to the United States fiscal cliff by addressing the expiration of certain provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (known together as the Bush tax cuts), which had been temporarily extended by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.

The following are some of the highlights and changes under the 2012 Act that will also apply to the tax year 2014:

  1. 39.6% Maximum Individual Income Tax Rate.  For the past decade or so, the top individual income tax rate was 35%.  Beginning in 2013, and continuing through 2014, the top rate is now 39.6% for income in excess of $400,000 (single) / $450,000 (joint).
  2. 20% Long-term Capital Gains and Qualified Dividends RateBeginning in 2013, and continuing through 2014, the top long-term capital gains rate and qualified dividends rate has increased from 15% to 20% for individuals with income in excess of the $400,000 (single) / $450,000 (joint).

IVCertain Federal Tax Law Changes (or Expiration of Favorable Tax Laws) in 2014 (unless and until extended by Congress).

As of this time, Congress has not extended any of the 57 provisions that expired on January 1, 2014, including the Section 179 expensing (drops from $500,000 in 2013 to $25,000), 5-year recognition of S Corp. built-in gains (reverts back to 10 years), the 100% exclusion of gain on the sale of 1202 qualified small business stock (reverts back to 50%), the ability of those age 70 1/2 and older to make direct distributions of up to $100,000 annually from their IRA’s to charity, the exclusion of $2 million forgiven debt on a debtor’s primary residence.

In April 2014, the Senate Finance Committee proved legislation (EXPIRE Act) that would extend nearly all of the tax extenders that expired after 2013. 
As discussed below, the Camp Proposal would extend only a handful of the provisions and allow the remaining ones to permanently expire.

As of now, it is more likely that the provisions will be revived, if at all, retroactively near the end of 2014.

V.  Current Tax Bills/Proposals. 

There are two leading tax proposals currently before Congress, including: (i) the House Ways & Means Chair Dave Camp proposal; and (ii) President's 2015 Budget proposal.  Each is discussed below.

  1. The Camp Proposal.  On February 26, Rep. Dave Camp, Chairman of the House Ways & Means Committee, unveiled his long awaited comprehensive tax reform package, called the Tax Reform Act of 2014, which is one of the most detailed tax reform proposals of the last 25 years (the "Camp Proposal").  

    The Camp Proposal is essentially revenue neutral and focuses on lowering tax rates and eliminating tax preferences and deductions,  Camp's Proposal would consolidate the current seven tax brackets into three, consisting of 10%, 25%, and 35%.  Single taxpayers with taxable income between $36,900 and $400,000 would pay tax at the rate of 25% and married taxpayers with taxable income between $73,800 and $450,000 would pay at a rate of 25%.  The top corporate tax rate would be reduced from 35% to 25%.
    Some of the key provisions in the Camp Proposal are the following:

    1. 1.  The Camp Proposal would repeal the AMT.
    2. The 3.8% Net Investment Tax and the 0.9% Additional Medical Care Tax would be retained.
    3. Self-employment tax would apply to any individual owner who materially participates in a business, including S corporations.
    4. Taxes capital gains and dividends as ordinary income.
    5. Principal Residence Exclusion.   Today, in order to exclude $250,000 ($500,000 if married filing jointly) of the gain from the sale of a principal residence, the taxpayer must have lived in the residence as their principal residence for 2 out of the past 5 years.  The Camp Proposal would change the period to 5 out of the past 8 years.
    6. Reduction in Home Mortgage Deduction.  Today, the amount of interest on home acquisition indebtedness that can be deducted is limited is $1.0 million.  Camp's Proposal would not allow any interest deduction for property purchased after 2014.  For taxpayers with acquisition indebtedness incurred before such time, the maximum that can be treated as deductible acquisition indebtedness is $875,000 for 2015, $750,000 for 2016, $625,000 for 2017, and $500,000 thereafter.
  2. The Obama Proposal.  President Obama's 2015 Budget (the "Obama Proposal"), released shortly after the Camp Proposal on March 4, 2014, focuses more on corporate tax reform and seeks to raise revenues for spending. 

    Some of the key items in the Obama Proposal are the following:

    1. 1.  President Obama has proposed to replace the AMT with the so-called “Buffet Rule,” which would impose a minimum tax of 30% on taxpayers with income over $1.0 million.
    2. Annual Gifts.  Right now, the annual gift tax exclusion is $14,000 per year.  A new category of property would be excludable up to $50,000 per year, including transfers in trust, pass-through entities, such as family limited partnerships, and other property that cannot be immediately liquidated by the donee.
    3. Section 179 depreciation expensing would be permanently increased to $500,000 per year.
    4. Qualified Small Business Stock (QSBS).  The Obama Plan proposes to make permanent the 100% exclusion for QSBS which, as of now, expired for QSBS acquired after December 31, 2013.
    5. Like-Kind Exchanges.  For exchanges completed after December 31, 2014, the deferred gain resulting from an IRC Section 1031 exchange would be limited to $1 million per year.
    6. Self-Employment Tax - Similar to the Camp Proposal, self-employment tax would apply to any individual owner who materially participates in a business, including S corporations.
    7. Research Credits.  The R&D credit has been temporary extended since the 1980s.  Similar to the Camp Proposal, the Obama Plan would make this credit permanent.
    8. Math Error Authority.  The IRS's math error authority, which allows the IRS to correct certain mistakes unilaterally, would refer only to computational errors.  Nevertheless, a new category of "correctable errors" would be created, including where information provided to the IRS (e.g. Form 1099) does not match what is reported on the tax return.

VI.  Summary. 

We now have a better understanding of the new laws that become effective last year 2013.  This should help with tax planning and filing for the tax year 2014.  Nevertheless, with the failure of Congress to pass over 50 tax provisions that expired at the end of the 2013, but which are usually passed early in the tax year, this makes such planning a bit more complicated.  Lastly, the recent tax proposals published by Congressman Camp and President Obama suggest that significant tax changes are coming in the very near future.

-- Eric D. Swenson is an attorney at the law firm Procopio Cory Hargreaves & Savich LLP in San Diego where he practices in all areas of taxatin including tax controversy and tax planning. 

-- Brent L. Gastineau is a Certified Public Accountant with Gatto, Pope & Walwick, LLP in San Diego where he provides tax planning and compliance services to a wide range of closely held businesses and their owners.

1 “Modified Adjusted Gross Income” is generally AGI, plus excluded foreign earned income and deductions taken into account in determining AGI.  See IRC Section 1411(d).

2 Thus, the Medicare tax rate can be as high as:  employer 1.45%, employee 2.35% (1.45% + .9%), and self-employed 3.8% (2.9% + .9%).  See TD 9645, final regulations issued in December 2013.

3 For a comprehensive discussion of the Camps' Proposal, see the Tax Reform Act of 2014, Discussion Draft, Section-by-Section Summary.

**This article is intended for informational purposes only and does not constitute legal advice. Any views expressed are those of the author only and not of the SDCBA or its Business & Corporate Law Section.**