President’s “Plan For Economic Growth and Deficit Reduction”

I was reviewing the tax provisions of the President’s “Plan for Economic Growth and Deficit Reduction.” It is possible that the “Super Committee” may adopt some of the tax provisions, so perhaps it is worthwhile to review the proposals.

(1)  Extend through 2012 the 100% bonus first-year depreciation.

(2)  Reduce the employer portion of the social security tax from 6.2% to 3.1%.

a.       This would cap-out at $5 million in payroll.

b.      Therefore the maximum cut would be $155,000 ($5,000,000 times 3.1%).

(3)  Create a tax credit for hiring employees who have been out-of-work for more than 6 months.

(4)  Create a tax credit to offset the increase in social security tax attributable to payroll increases over the corresponding period of the preceding year.

a.       So if your payroll was $1 million last year and $1.5 million this year, you would receive a credit for the social security taxes on the $0.5 million increase.

b.      There is a cap of $50 million.

c.       The credit would be good for the last quarter of this year and all of 2012.

(5)  The pre-EGTRAA tax rates would return for those making over $200,000 and $250,000.

OBSERVATION: Senator Schumer thinks these limits should be higher for New Yorkers. He is the senator from … New York.

(6)  Limit the tax rate at which high-incomes can reduce their tax to 28% for itemized deductions, excluded foreign income, health insurance and other selected deductions.

OBSERVATION: Right… make the calculation so complicated that even tax software won’t be able to get it right. Perhaps Congress and the WH should start with eliminating the phase-outs for personal exemptions, itemized deductions, student loan interest, education credits, child credit, AMT exemption and etc that would make this a circular calculation to stress even a mathematics graduate student.

(7)  Reduce the employee social security tax from 6.2% to 3.1%.

OBSERVATION:  Read this in conjunction with (2) above.

(8)  Repeal last-in first-out accounting (LIFO).

OBSERVATION: There is no accounting reason for this, as LIFO is considered to be a generally accepted accounting principle. It forms the tax accounting backbone of virtually every vehicle dealership in the nation.

(9)  Repeal the use of lower-of-cost –or-market inventory accounting.

OBSERVATION: Again, there is no accounting reason for this.

(10)  Increase the net FUTA tax from 0.6% to 0.8%.

OBSERVATION:  FUTA was increased on a “temporary” basis from 0.6% to 0.8% in 1976, although it went back to 0.6% this year. Does that sound “temporary” to you?

(11)  Eliminate the percentage depletion and intangible drilling cost provisions for oil and gas companies.

(12)  Eliminate coal activity expensing of exploration and development costs, as well as percentage depletion for hard mineral deposits and capital gains for royalties.

(13)  Modify the transfer-for-value exception on life insurance contracts.

OBSERVATION: Seems the viatical industry has drawn attention to itself.

(14)  Require business jets to be depreciated over 7 years rather than 5.

(15)  Revise the rules on transfers of intangibles to controlled foreign corporations.

OBSERVATION:  Think Google.

(16)  Revise the rules on the deductibility of interest paid to foreign persons.

I leave it to you to deem how serious you consider these proposals.

Hiring Your Child

If you own a business, would it make sense to hire your child? There are different facets to this question, and the one we will discuss today are the tax consequences.

Income Taxes

You can pay your child up to $5,800 without either of you incurring an income tax liability. As long as the wages are reasonable for the work performed, the wages are deductible to your business and taxable to your child. The child’s standard deduction of $5,800 can reduce the child’s taxable income to zero, effectively sheltering the wages.

Is the “kiddie tax” a consideration? The answer is no, as the kiddie tax applies to the transfer of passive income, such as interest and dividends. The income we are discussing is earned income, and the kiddie tax does not penalize earned income.

How much can you save? Well, that depends on your tax rate. If you are in the 35% tax bracket, then you are saving $2,030 in federal income taxes alone ($5,800 times 35%). This amount may be less if there is social security or you as employer have to pay federal unemployment tax. What are the rules for those taxes?

Social Security Tax

The social security consequence will vary depending on the age of the child and whether you are self-employed.

The first requirement is that the child must be under the age of 18.

If you are self employed (which is to say, you are unincorporated and file a Schedule C), you do not have to withhold or pay FICA taxes on a child under the age of 18. If you are under the FICA limit for 2011, this may be an immediate tax savings of 14.13% (15.3% times .9235). If you are over, then the FICA savings reduce to 2.68% (2.9% times .9235).

If you are incorporated, then there are no social security savings, as a different rule applies.

What if you are a partner in a partnership (or a member in an LLC)? If the only partners (or members) are the parents, then you do not have to withhold or pay FICA. Otherwise the corporate rule applies.

Federal Unemployment Tax

The same rule as for FICA applies here, with one exception. If the child works for your unincorporated business, or in a partnership (or LLC) where you and your spouse are the only partners (or members), then the wages will not be subject to FUTA. Otherwise, FUTA will apply.

The exception is the age cutoff. For FUTA, the child must be under age 21.

Income Tax Withholding

Usually, an employee who had no income tax liability for the prior year and expects none for the current year can claim exempt status and have no federal income tax withholding. There is a different rule for children who can be claimed as dependents on their parents’ return. That child cannot claim exempt status if his/her income will exceed $950 AND include more than $300 of interest, dividends and passive income of that nature.

Mind you, it is possible that you will get back the withholding when your child files his/her individual income tax return.