One thing is certain about being a CPA dedicated to tax practice– we see a variety of clients. Over time, most CPA firms service clients ranging from poor college students to high net-worth retirees. Clients from all income levels also turn to us for financial planning advice designed to reduce their tax bill. Our firm serves its share of lower-income taxpayers. We advise clients on ways to stretch their investment dollar to keep it from Uncle Sam and put more in their pockets.
This upcoming tax season, we will provide valuable advice to our lower-income clients thanks to a provision in the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), signed into law on May28, 2003. Yes, this five-year-old law passed to stimulate the economy after 9/11 and the beginning of the Iraq war contained an unheralded provision allowing for the elimination of the long-term capital gains tax (tax on the gain of sales of assets held by the taxpayer for more than one year) for the 2008 tax year for tax payers in the 10% and 15% tax brackets. It was lost in the press in favor of the more immediate capital gains rate reductions to 5% for low-income taxpayers and 15% for higher-income filers.
Originally only scheduled for the 2008 tax year, the capital gains tax elimination was extended for two more years (through the 2010 taxyear) thanks to the Tax Increase Prevention and Reconciliation Act (TIPRA) of 2005. This provides a three-year window for a large number of taxpayers to take advantage of selling assets they may have bought with college planning or retirement in mind. After 2010, unless Congress intervenes in the interim, the lower-income capital gains rate will revert to its pre-JGTRRA rate of 10%.
To take advantage of the zero capital gains tax provision, a single taxpayer must have taxable income of less than $31,850 (the amount of the 2007 15% tax bracket maximum; the 2008 tax rate schedules,with a slight increase for inflation, will be released this fall). A married filing joint couple must have made less than $63,700 (again, 2007numbers with a slightly increased 2008 total yet to be released) to qualify. For head of household filers, the maximum amount would have been $42,650 in 2007.
In addition, the capital gain tax exemption is not an all-or-nothing proposition in the event that the gains take the client over the maximum income threshold. For example, if ordinary income, without capital gains, is below the maximum, but through capital gain sales, income is pushed above the maximum, only the amount attributed to income above the maximum is subject to tax (15%), while the capital gain income below the maximum would not be taxed.
So what does this mean? The new rules provide a wonderful opportunity for practitioners to give value-added service to a large percentage of their client base. According to the IRS, 63% of filers in 2003 fell within the 10% or 15% brackets. In addition, as recently as 2005, the median income for all households was $46,000, well within the 15% bracket.1 That should translate into a large percentage of a given CPA’s client base falling with the acceptable income range to take advantage of the three-year Uncle Sam giveaway.
What scenarios, then, can CPAs be of use to their clients? First, for example, you have a client who is approaching retirement. He has held aggressive growth positions in mutual funds to achieve growth, but with retirement coming up, he needs to shift his portfolio to a more conservative income position. He can sell his higher-risk growth securities tax-free and invest those funds into more stable bond or money market funds.
Second, say you have a younger client with maybe a 15- to 20-year window to retirement. They have had fund investments that have performed well for several years and still have time for some more growth. They have not sold because of the tax. They could sell their positions in the funds, foregoing the tax, and then simply repurchase shares from the same fund, giving the client a higher cost basis and therefore a lower taxable gain when he does sell them for good.
A third scenario is for someone who has a child who is going to college in the next few years. As part of a more comprehensive college savings plan, since a three-year window of opportunity exists, they could purchase investments now, hold them for up to 27 months as of the time of this writing, and sell them the fund college without some of the money going to the government, but rather as a tuition payment.
While we’re talking about children and tax-free capital gains in the same article, it’s important to note a major change in the kiddie tax. To put the kibosh on higher-income parents giving investments to their teenage children with the intent of the children to sell them tax-free using their lower income,Congress, in 2006, raised the maximum age covered by the kiddie tax from 13 to 17. And snuck into an Iraq funding bill in May of 2007, the maximum age was aligned with the dependency age, which is 19, or 24 for full-time college students.2 However, for higher-income taxpayers, they can give investments to their parents to assist them in their retirement. A person with income exceeding the income threshold can give investments to parents within the gift tax limits, and the investments can be sold tax-free. However, thorough research must be done to examine the effect of such a gift and saleon a parent’s taxable income so that Social Security benefits are not taxed and Medicare benefits are not affected.
As with all investment advice, great care must be taken to project the effecton sales of investments on a client’s taxable income, that the funds are not in tax-advantaged vehicles, and that all elements of risk are thoroughly explained to the client. In addition, ensure any investment advice given to aclient is in line with their risk tolerance profile and investment time horizon.
It’s not often that Congress allows the ordinary taxpayer a way to make money without paying a good chunk of it back in taxes. But until Dec. 31, 2010, a large percentage of your clients will be able to do just that. Make this advice an important part of your 2009 tax season preparation and communication with your clients.
1 David Mcpherson, Capital Gains Tax Cuts for Middle Income Investors, Investopedia
2 Sandra Block, 2008 Drop in Capital Gains Rate Won’t be for Everyone, USA Today, June 15, 2007 |
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