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This course has been updated to include content on the Emergency Economic Stabilization Act of 2009
This information-packed course is brimming with the latest innovative techniques for building and conserving wealth, employing beneficial tax planning and investment strategies. AICPA tax experts dissect the details of the most current tax laws and other new developments to extract every sliver of tax benefits.
Objectives:Prerequisite: Basic knowledge of individual income taxation
Accepted for PFS credit.
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Chapter 0 - Overview
Introduction
This course describes and illustrates practical tax-planning techniques in several key individualtax areas. Many of the techniques covered in the course may be applied across a wide range of taxpayer income levels.
Organization
Topic by topic, you will be guided through tax-saving techniques and strategies that are illustrated by practical examples. Where alternate strategies exist, you will review the advantages and disadvantages of each, so that you may assist your clients in making appropriate choices.
Most chapters have questions to reinforce the concepts covered in the chapter. In addition, Chapter 7, which covers planning strategies relating to divorce, contains a series of practice aids that you may adapt to your own practice needs.
Conclusion
The manual is designed to be a permanent reference tool. We hope your reading of this manual enriches your professional learning experience.
Note. We use the terms he and she alternately throughout the course (except when a particular person is mentioned) since both sexes are well represented throughout the profession.
Chapter 1 - Maximizing Tax Benefits for Sales of Capital Gain Assets and Real Property
Learning Objectives
• Negotiate the intricacies of the current tax structure for capital gains to help clients maximize their tax savings when buying and selling capital and §1231 assets.
• Help clients take advantage of the special §1237 tax break for real estate subdividers.
• Help real estate owners take advantage of the tax-deferred like-kind exchange provisions of IRC §1031.
Introduction
This chapter covers what practitioners need to know from both planning and compliance perspectives to help clients maximize tax savings under the current rate structure for capital gains, which is effective through 2010 (unless Congress changes its mind).
In addition, this chapter covers a special exception under IRC §1237, which grants capital gain treatment to certain sellers of subdivided lots. With today's low capital gains rates and an abundance of built-in real estate gains (despite recent market declines in many areas), the §1237 exception continues to be an important break for landowners.
Finally, this chapter covers §1031 like-kind exchanges for clients who are obsessed with outright avoidance of capital gains taxes.
Capital Gains Tax Rates in a Nutshell
After repetitive law changes, the federal income tax rates on capital gains are more confusing than ever. That said, the current rates are also more beneficial than ever.
Key Point. The author does not expect all of the current individual federal tax rate structure to stay in place beyond 2010. Predictions (for what they are worth) are made, at the time of this update, in appropriate places throughout the discussion that follows.
Reduced Capital Gains Rates for Sales through 2010
Thanks to the Jobs and Growth Tax Relief Reconciliation Act of 2003 (the 2003 Act) and the Tax Increase Prevention and Reconciliation Act (TIPRA), most long-term capital gains earned by individuals through the end of 2010 will be taxed at significantly lower federal income tax rates. The reduced rates also apply to the deferred capital gain component of installment note principal payments received by sellers after May 5, 2003 and before 2011. Specifically,
• Most long-term capital gains are taxed at a maximum rate of only 15%.
• For 2008-2010, most long-term capital gains that would otherwise fall within the 10% and 15% ordinary income rate brackets will be taxed at 0%. Now that is an unbeatable rate!
• Many more folks than you might think will pay a marginal ordinary income rate of 10% or 15% and thus be eligible for the 0% rate in 2008-2010. More on that later in this section.
• Gains from the sale of qualified small business corporation (QSBC) stock held for more than six months can be rolled over tax-free if the seller reinvests the proceeds in other newly issued QSBC stock (as explained later in this chapter). This provision is the same as under "old law."
• Capital gains from principal residence sales can be entirely excluded from federal income taxation to the extent of up to $500,000 for joint filers and up to $250,000 for unmarried individuals (assuming the qualification rules are met).
Some Gains Do Not Qualify for Reduced Rates
Unfortunately, the 15%/0% rates were not extended to all types of capital gains. Specifically,
• The reduced rates have no impact on investments held inside a tax-deferred retirement account (traditional IRA, Keogh, SEP, solo 401(k), and the like). So, the client will pay taxes at her regular rate (which can be as high as 35%) when gains accumulated in these accounts are withdrawn as cash distributions. (Gains accumulated in a Roth IRA are still federal-income-tax-free as long as the requirements for tax-free withdrawals are met.)
• Clients will still pay taxes at their higher regular rates on short-term capital gains from investments held for one year or less. These short-term gains still count as ordinary income, just as they did under "old law." Therefore, if the client holds appreciated stock in a taxable account for exactly one year, he could lose up to 35% of his profit to the IRS. If he instead holds on for just one more day, his tax rate drops to no more than 15%. The moral: selling just one day too soon could mean losing up to 20% more of one's profit to the tax collector.
Key Point. For tax purposes, the client's holding period begins the day after he acquires securities and includes the day he sells. For example, say your client buys shares on November 1 of this year. His holding period begins on November 2. Therefore, November 2 of next year is the earliest possible date he can sell and still be eligible for the reduced rates on long-term capital gains. (See Rev. Ruls. 66-7 and 66-97.)
• Section 1231 gains attributable to depreciation deductions claimed against real estate properties are called unrecaptured Section 1250 gains. These gains, which would otherwise generally be eligible for the 15% maximum rate, are still taxed at a maximum rate of 25% as they were under "old law" [IRC Sec. 1(h)(6)]. The good news: any Section 1231 gain over and above the amount of unrecaptured Section 1250 gain from a real property sale is generally eligible for the 15% maximum rate on long term capital gains. The same treatment applies to the deferred Section 1231 gain component of installment note payments received after May 5, 2003, from an installment sale transaction, even though the sale date may have been before May 5, 2003.
Key Point. Distributions from REITs and REIT mutual funds may include some unrecaptured Section 1250 gains from real property sales. These gains, which are still taxed at a maximum rate of 25%, should be separately reported to the investor and entered on the appropriate line of the investor's Schedule D.
• The "old-law" 28% maximum rate on long-term capital gains from sales of collectibles and QSBC stock remains in force [IRC Sec. 1(h)(5) and (7)].
Sunset Rule. After 2010, the "old-law" capital gains rates will return unless Congress takes further action. The author's best guess is that the existing rate structure on longterm gains will be kept in place except for those in the top two tax brackets. For them, the maximum rate on most long capital gains may increase to 20% (up from the current 15%) for post-2010 years.
Alternative Minimum Tax (AMT) Treatment of Capital Gains
The preferential capital gains rates apply equally for both regular tax and AMT purposes. However, significant capital gains can still push individuals into the AMT mode. Why? Because the additional taxable income from the gains can cause the individual to lose some or all of her AMT exemption due to a phase-out rule. In addition, the additional taxable income from the gains can trigger higher state income taxes. Since the deduction for state income taxes is disallowed under the AMT rules, this increases the odds the individual will owe the AMT.
Qualified Dividends Taxed at Capital Gains Rates, Too
Thanks to the 2003 Act and TIPRA, qualified dividends are now taxed at the same federal income tax rates as long-term capital gains through 2010.
• Qualified dividends are taxed at a maximum rate of 15%.
• For 2008-2010, qualified dividends that would otherwise fall within the 10% and 15% ordinary income rate brackets are taxed at the unbeatable rate of 0%.
• Many more folks than you might think will pay a marginal ordinary income rate of 10% or 15% and thus be eligible for the 0% rate for 2008-2010. More on that later in this section.
Not All Dividends Are Eligible for Reduced Rates
The reduced 15%/0% rates on dividends apply only to qualified dividends paid on shares of corporate stock [IRC Sec. 1(h)(11)]. However lots of payments that are commonly called "dividends" are not qualified dividends under the tax law. For instance,
• Dividends paid on credit union accounts are really interest payments. As such, they are considered ordinary income and are therefore taxed at regular rates . which can be as high as 35%.
• The same is true for dividends paid on some preferred stock issues that are actually publicly traded "wrappers" around underlying bundles of corporate bonds. So clients should not buy preferred shares for their taxable accounts without knowing exactly what they are buying.
• Mutual fund dividend distributions that are paid out of the fund's short-term capital gains, interest income, and other types of ordinary income are taxed at regular rates. So equity mutual funds that engage in rapid-fire trading of low-dividend growth stocks will generate payouts that are taxed at up to 35% rather then at the optimal 15%/0% rates your client might be hoping for.
• Bond fund dividends will also be taxed at regular rates, except to the extent the fund is able to reap long-term capital gains from selling appreciated assets.
• Here is the good news: mutual fund dividends paid out of (1) qualified dividends from the fund's corporate stock holdings and (2) long-term capital gains from selling appreciated securities are eligible for the 15%/0% rates. This means mutual fund annual
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