Are You Ready for Tax Armageddon?

Armageddon appears once in the Bible and relates to the final conclusive battle between the forces of good and evil.  The word, Armageddon, has also become a general term that denotes any disastrous "end of the world" event.  With the looming tax law changes, the popular press has coined a new phrase, "Tax Armageddon" or "Taxmageddon" for short.  Assuming that the world survives the end of the Mayan calendar on December 21, 2012, then we face the largest tax increase in history on January 1, 2013!  The tax increase is estimated to be $500 billion for 2013 alone.  However, even this historic tax increase won't pay for half of the projected Fiscal 2012 budget deficit of $1.3 trillion!  To pile on, the federal debt ceiling will likely be reached around this same time.  To pile even higher, the failure of the "super committee" last fall requires $1 trillion in spending cuts over 10 years, beginning January 1, 2013, divided half between military and social spending.  This nation truly has severe budgetary problems, and failure to solve these problems is the true Armageddon that must be avoided.

Just what taxes are increasing and what can you do about them?  This post outlines the major categories of tax increases.  Future articles will explore the increases in more detail and outline available planning opportunities.  We expect that Congress may act to prevent some of these increases, but what can we really count on from Congress?

1. The so-called Bush tax cuts of 2001 and 2003, originally set to expire at the end of 2010 are now set to expire at the end of 2012.  Significant cuts included the lowering of all of the ordinary tax rates, including the top rate from 39.6% to 35.0%.  The top long-term capital gain rate was cut from 20% to 15% and the qualified dividend rate cut from 39.6% to 15.0%.  In addition, a host of other cuts were made including eliminating the loss of itemized deductions and personal exemptions based upon income levels, increasing a variety of personal and education tax credits, and reducing the so-called marriage tax penalty.
2. The exemption from estate and gift tax in 2012 is $5.12 million.  The exemption declines to $1.0 million in 2013.  In addition, the top estate and gift tax rate increases from 35% to 55%.
3. The alternative minimum tax exemption amount declined from $74,450 and $48,450 for joint and single filers in 2011 to $45,000 and $33,750 in 2012.  This decline will increase taxes on 30 million taxpayers unless the exemption is once again "patched" with a new temporary increase.
4. The employee portion of the Social Security tax was reduced from 6.2% to 4.2% for 2012.  The rate will revert to 6.2% in 2013.
5. Business 100% bonus depreciation on the purchase of new equipment in 2011 declined to 50% in 2012 and then is eliminated in 2013.
6. New Medicare taxes are imposed on compensation and investment earnings in 2013 as part of the so-called Obamacare tax provisions.  Compensation above certain thresholds will suffer an extra 0.9% tax.  Investment income of taxpayers having modified adjusted gross income above certain thresholds will, for the first time, be subject to Medicare tax, at a rate of 3.8%.  The U.S. Supreme Court is expected to issue its ruling on the constitutionality of the Affordable Care Act by the end of June 2012.  Whether this ruling will impact the Medicare tax increase remains to be seen.

Understanding Tax Issues of Employee Expense Reimbursement Plans

Employers will generally reimburse or provide advances to cover ordinary and necessary business expenses incurred by their employees for travel, meals, and entertainment.  Specific tax rules, including time limits, must be observed to avoid income tax pitfalls.  There are two tax categories of expense reimbursement plans:  accountable (tax favorable) and nonaccountable (tax unfavorable).

For an accountable plan, the employee must timely document the expenses to the employer and also timely return any excess reimbursement or advance to the employer.  The time requirements are as follows:

1. The employer may not provide an advance more than 30 days before the time the employee will incur the expense.
2. The employee must provide adequate documentation of expenses within 60 days after the expense was paid or incurred.
3. The employee must return any excess reimbursement within 120 days after the expense was paid or incurred.
4. If the employer gives periodic statements (at least quarterly) to the employee asking for an accounting of the expenses and a return of any excess reimbursement, then employee must comply within 120 days of the date of the statement.

The tax benefit of an accountable plan is that the expense reimbursement is not treated as taxable wages.

In lieu of actual expenses, per diem amounts for lodging and meals and incidental expenses, and mileage rates for driving a personal car for business may be used.  As long as the amounts do not exceed the rates published by the IRS, and the employee otherwise provides documentation, the employee is deemed to have met the accountable plan rules and any excess does not need to be returned to the employer.  See IRS Publication 1542 for per diems rates.  The business mileage rate for 2012 is 55.5 cents per mile.

A nonaccountable plan is an arrangement that does not meet the rules for an accountable plan.  Also, if the employee does not comply with the time requirements, then the expense reimbursements are treated as though paid under a nonaccountable plan.  The amounts paid under a nonaccountable plan are treated as regular taxable wages, subject to income and payroll tax withholdings, and are reported on Form W-2.  The employee may then deduct the business expenses, but they are miscellaneous itemized deductions.  Miscellaneous itemized deductions only provide tax savings to the extent the total exceeds 2% of adjusted gross income, if the employee has itemized deductions in excess of the standard deduction, and if the employee is not subject to the alternative minimum tax!  There are a lot of hurdles for an employee to clear to receive a tax deduction for business deductions under a nonaccountable plan, so it is advisable for the employee to comply with the accountable plan rules to avoid very negative tax results.