In the world of tax, it is about keeping it, not making it. We share our revenues with Uncle Sam (and Uncle Jerry). Last December, Congress and the President made history with the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act, an amazing collaboration of the parties which took us all by surprise.
So how did attorneys fare? The top income tax rates, which were scheduled to rise to 39.6% from 35%, will remain at 35% for two years. Capital gains rates will remain at 15% and dividends will continue to be taxed at capital gains rates. However, most attorneys in California determine their tax due by calculating their tax under the alternative minimum tax scheme. Under this calculation, taxpayers are not allowed to deduct state income or property taxes. The rate applied is lower than the regular rates, but with California’s high state income tax not allowed as a deduction, the alternative tax is the tax paid by most attorneys.
There has been little change in the calculation of the alternative minimum tax. There has been a cost of living adjustment upward in the exclusion. Otherwise, the calculation will remain the same until January 1, 2013. With a presidential election looming in 2012, we will have to wait and see where the rates go in 2013.
More important for attorneys, the self employment tax (and Social Security Tax for those receiving a paycheck) will be cut by 2% for 2011. This is a automatic raise of two percent in the amount taxpayer’s keep.
In 2013, attorneys will be taxed an extra 3.8% on their unearned income and 0.9% on self employment income. While retirement income avoids the definition of unearned income, gain of sales of non-business property does not.
All property purchased for the business can be expensed, bringing the current tax bill down. There are a few limitations which won’t apply to most practitioners. On the other hand, it may be advantageous to depreciate the property over a period that will see higher tax rates.
The itemized deduction phase-out is suspended for two years.
Incorporating allows the taxpayer to pay a salary to him or her which will include withholding. If the corporation is an S Corporation, the balance of the income (after deducting the salary) is not subject to self employment tax. As to whether this advantage makes up for the fees associated with incorporating, talk to an accountant.
For those that receive fees from low income tax states such as Nevada, Washington, Texas, Alaska and Florida, the practitioner may want to consider moving to one of those states to receive tax free income. The sad fact is that California is one of the most heavily taxed states. For any attorney with a large taxable event looming in the horizon, it would be well worth the time to analyze the advantages of a change in residency.
For those of us that die, our children will receive much more under the new law. The exclusion (the amount we don’t pay tax on) is set at $5,000,000 with a 35% rate on property transfers exceeding $5,000,000. The same is true for the gift tax, making this two year window an ideal time to consider gifts. It may be advantageous to wait until late in 2012 to make the gifts since there are a large number of commentators that believe that the estate tax may be repealed before the end of 2012 when the current rates cease.
Of course, part of increasing income is avoiding penalties. Unless it is repealed, you are required to file a form 1099 for payments to corporations and payments for goods (not just services) of over $600. Amazingly, the legislative record includes billions of dollars as a “revenue raiser” from the $50 penalty for each failure to comply.
For the self employed, making those quarterly payments is a problem. The estimated penalty is the equivalent of a low interest loan (3% currently – not deductible) and it may be appealing to pass on the payments. The big penalties are associated with failure to file and failure to pay payroll taxes for employees. This should never be an option. The failure to pay tax liabilities carries penalties and interest roughly equal to market rates, but subjects the taxpayer to the IRS collection process which is an unpleasant experience at best.
Earning more income is at the top of everybody’s agenda. Keeping an eye on keeping it can equally profitable.
Mr. Ericsson practices taxation, business and estate planning law as a partner in the Walnut Creek firm Youngman & Ericsson and is a past president of both the Contra Costa County Bar and its taxation section.
Filed Under: Spotlight