Michigan starts its tax form with AGI (from the Federal 1040), then makes adjustments from there.  This is not unusual- many states start at Federal AGI.  For retirees, the adjustments Michigan makes are generally subtractions.  Michigan is exempting income from taxation.

Born before January 1, 1946:

• If you were born before 1946, you get lucky- there is no change to your income taxes.  You will do your income taxes exactly how you did them in 2011 and before.  You are the one group of retirees that is not impacted by the changes and most of your income will remain not taxed by Michigan.

Born after December 31, 1945 and before January 1, 1953:

In the next two groups, taxation depends on how old you are.  If you are married filing jointly, it depends on how old the older of you is.  The line is age 67.  In each category, different sources of income are exempt from taxation (though in both age groups, Social Security is exempt from taxation.)

• Younger than age 67: 
• Social Security, Military pension and Railroad retirement is exempt from taxation
• Pension income (including 401K/403B, Traditional IRA, Annuities) are excluded UP TO $20,000 (single) or $40,000 (Filing Joint).  This is considerably lower than Private pension of $45,842 exempt (Single) and $91,684 (Joint) that you used to be able to take (or that your friends born before 1946 can take.
• You can’t take the special Senior exemption for Dividends, Interest and Capital Gains.

• Older than age 67:
• Social Security is exempt from taxation
• Pension income (including 401K/403B, Traditional IRA, Annuities) are excluded UP TO $20,000 (single) or $40,000 (Filing Joint).  As mentioned, this is considerably lower than Private pension of $45,842 exempt (Single) and $91,684 (Joint) that you used to be able to take (or that your friends born before 1946 can take.
• You’re not eligible for the $20K/$40K exemption if you claim the Railroad and Military Pensions exemption.
• You can’t take the special Senior exemption for Dividends, Interest and Capital Gains

So as you can see, the State is making it more expensive as you get younger.  Apparently the thinking is that the younger you are, the more time you have to adjust your behavior, your spending and your saving.

There is one more age group, and these folks have it worst:

Born on or after January 1, 1953:

Again it depends how old you are, and again, age 67 is the dividing line:

• Younger than age 67: 
• Social Security, Military pension and Railroad retirement is exempt from taxation
• Pension income (including 401K/403B, Traditional IRA, Annuities)  UP TO $20,000 (single) or $40,000 (Filing Joint) is NOT excluded from income.
• You can’t take the special Senior exemption for Dividends, Interest and Capital Gains.

• Older than age 67:
• You’re not eligible for the $20K/$40K Public or Private Pension exemption.
• You can’t take the special Senior exemption for Dividends, Interest and Capital Gains.
• You have a choice about which income you can exclude from taxation.  Obviously, you would want to exclude the maximum amount of income:
• Exclude $20,000 (single) or $40,000 (MFJ) of ALL Income (No additional exemption for Social Security, Railroad or military pension, no personal exemptions).  OR
• Exclude Social Security, and Military Railroad Pension, and claim personal exemption

Here are a couple things to think about:

1. As you can tell, more of Michigan retiree income is taxed, and this is probably a precursor to how the Federal Government will increase taxes:  They won’t increase rates (Michigan’s tax rate did not increase- it’s still 4.35% of taxable income), they will just subject more income to taxation.
2. As mentioned, the point is to lessen the tax burden to small businesses so they will increase hiring, and absorb some of the tax burden.
3. This is probably not the final iteration of the tax laws.  Some people affected have been fighting the new law in court, but so far, only a small part of the law has been struck down.

Like any other change, look for people to adjust.

One group that had its tax burden increased is Retirees.

I had mentioned earlier that prior to 2011, Michigan was a good place to retire because much of retirees income was exempt from State Taxation.  Prior to 2012, Retiree income that was exempt included most Private Pension income (including IRAs, earnings on 401K and 403B, annuities, disability income), ALL Public Pension income, and Social Security Income (including Railroad retirement and military retirement).  Senior Citizens could also subtract dividends, interest and capital gains.  Finally, after subtracting exemptions, Retirees often had a negative taxable income.  To top it all off, many retirees received a refundable homestead credit.  That is why I wrote that Michigan was very kind to retirees.  Michigan was one of maybe 5 states that taxed its retirees this lightly.

The new law changes that.  Michigan changes from being a great place to retire, to being a good place to retire.

How might you be affected?  It depends on when you were born, and your age.  I’ll try to explain that in my next post.  But if you want to get the first hand info, click here to visit the State of Michigan Website for a pretty good explanation.  Read the explanation, and I’ll explain it in my next post.

There are new Lease Accounting Rules coming soon.  Many Small Businesses lease many of their assets because instead of owning an asset, they can rent it and get the same economic benefit in a cheaper manner.  So if the accounting rules are changing soon, what does this mean, and how will it affect many small businesses?  Let me explain.

Currently there are two types of leases:  Capital Leases and Operating leases.  An operating lease is very simple.  As you pay off your lease, youdebit rent expense and credit cash.  End of Story.  For instance, Office space and Office Equipment is often accounted for in this manner.  In many cases, it makes little sense to tie up capital by purchasing office equipment or office space, so renting it solves the problem.  The assets are not on the leasee’s books, and as long as the leasee makes his monthly payment, everyone is happy.

The other type of lease is called a Capital Lease.  In a capital lease, the business puts the asset on the balance sheet as both an asset and a liability.  As each monthly payment is made, a small amount of the liability is deducted from the total, thus reducing the liability.  Also, the company can take depreciation expense against the asset.

As you may remember, to some extent, “Off Balance Sheet Financing” got many companies into trouble in the early 2000′s, so in 2005, the SEC specifically said the lease rules should be rewritten.

Affect of New Lease Accounting Rules

The main effect of the New Lease Accounting Rules is that Operating leases will go away.  Now all leases will be treated as Capital leases are now treated:  In ALL leases, there will be both an asset and a liability on the balance sheet of the company.

This will mean three main things to business owners:  First, ALL leases must now be scrutinized and accountied for in this manner.  At the end of every year, things like the useful life of the asset and cost of capital will need to be re-evaluated so to generate the proper values for the lease asset and lease liability.  The second thing is that your accounting bill is likely to increase because of the extra record keeping now required.

The third, and probably most important factor is that now, because of new lease accounting rules, debt ratios will change for ALL companies that lease assets.  The debt ratios will mostly increase, and this will make it increasingly difficult to borrow money. 

The new lease accounting rules will increase the cost of doing business and will mostly hurt small businesses.  It will make record keeping more time consuming and costly, and will increase debt ratios which will make borrowing more difficult and costly.  But unfortunately, the SEC and the business regulatory community believe that  the benefit to society of increased transparency will outweigh the cost to small business.

The goal of the Financial Accounting Standards Board and the International Accounting Standards Board is to have a final position on the new Lease Accounting Rules by the end of 2011.  These boards will seek input as to when it will be best to implement the new standard.

My guess is that the new lease accounting rules will take effect in 2013 or 2014.

You may know, if you’ve downloaded the 2011 material from this site) that the Making Work Pay credit for 2011 is going away.  I have been hearing that the withholding tables for 2011 have changed to withhold a bit more of your paycheck to compensate for this credit being eliminated.

The whole discussion is a bit hard to follow but here are the basics:

• In 2009, Congress changed the withholding (but not the tax rate) so that people would have more in their pocket to spend each week.
• Congress did not change the tax rate, just the withholding amount.
• Eventually, people realized that when Americans did their taxes, most working Americans would owe money on April 15, 2010.  That is because the amount of tax was not changed, just the amount withheld to cover the tax was less.
• To compensate for the expected outcry, Congress installed the “Making Work Pay” Credit which helped buffer the expected shock. This credit applies for tax years 2009 and 2010.

Last December, when Congress decided what its tax policy would be for 2010, 2011 and 2012, the Making Work Pay credit was one credit that was eliminated.  At the same time, withholding tables are going back to somewhere near what they were during 2008.  For most working Americans, this will mean that the amount withheld will be slightly higher.

Please note, your year end tax liability (for the amount of money you earn) will not change.  Just the amount you have withheld to pay your tax liability will change.

How will this affect you?  I estimate that on average, each person’s weekly take home pay will decrease between $10 and $20.  But the amount of your refund (or the amount you owe the IRS) on April 15 of 2012, should not be significantly different from this year, if your circumstances have not changed.

Bottom Line: You’ll have a little less take home pay this year.

I’ve noticed that from an income tax perspective, Michigan is very kind to retirees.  Michigan does not tax Social Security Income, Pension Income (from defined benefit plans, or government pensions) or IRA distributions.

However, Michigan does tax the gain on any 401K plan from which retirees take distributions.  This makes a mess for taxpayers and tax preparers.  It can be very difficult to determine the amount of the distribution that is gain, and the amount that is principal (contributed by the Taxpayer or his employer).  Then think about doing this every year.  So to properly determine the tax on the 401 K distribution, the Tax Preparer needs to know the principal (amount contributed- this piece is not taxable) and the gain by that principal (this part is taxable).  Fortunately, there is an easier way that reduces taxes to the State of Michigan.

Here is the Tax Break:  Convert your 401K to a traditional IRA. Distributions from an IRA, as mentioned above, are not taxable to the State of Michigan.  This not only saves you time, but more importantly saves you money.

So if have retired and you have a 401K from which you receive monthly distributions, convert the 401K to a Traditional IRA, and stop paying Michigan Income tax on the distribution.

Converting is as easy as going to see your Wealth Management Adviser, and telling him that you want to do this.  He will quickly get you to sign the right forms and you’ll soon be paying less tax to the State of Michigan.

Tax Breaks that Expired in 2010:

1. Increased Standard Deduction for Real Property Tax:  In 2009, if you had a house and paid property tax but could not use Schedule A to Itemize your deductions (because the itemized deductions would not add to more than the standard deduction), you were allowed to add some or all of your property tax to your standard deduction to increase the standard deduction.  Single filers received $500 additional, Married Filing Joint received $1,000 additional.  In 2010, that break went away.
2. New Vehicle Sales Tax Deduction: In 2009, if Taxpayers purchase a Brand New vehicle after Feb. 17, 2009 and before January 1, 2010, they could increase either their itemized deduction or their standard deduction by the amount of the State and Local Sales tax, and Excise Tax.  This break will not be allowed for 2010.
3. Unemployment Compensation: In 2009, the first $2,400 of Unemployment Compensation was not subject to Federal Income Tax (thought some states did tax it).  In 2010, all Unemployment Compensation is subject to Federal Income Tax.
4. Required Minimum Distribution Waiver: In general, IRAs are subject to Required Minimum Distributions (RMD), meaning at some point, the Government requires that Taxpayers with IRAs take distributions from their IRAs and make that income subject to federal tax.  There is a formula that determines the minimum amount of distribution from the IRA that a taxpayer must take every year.  In 2009, Taxpayers received a waiver, effectively removing (for one year) the requirement that they must take the RMD from the IRA.  So the taxpayer could leave the money in the IRA for one year, let it grow, and not be subject to income tax or penalties.  In 2010, this waiver expired, and any taxpayers not taking their Minimum Distribution in 2009, must again take it in 2010.

While Congress extended many taxpayer friendly provisions of 2009, these are a few tax breaks that did expire in 2010.

Required Minimum Distributions:

If you have a Traditional IRA and you are over 70 1/2, you are required to take required minimum distributions every year. (Having said that, 2009 was a one time exception).  Basically, you look up your age in a table, and find the corresponding factor (essentially, and estimate as to how many years you have left to live).  You take the amount in your IRA, divide by this factor, and you get your Minimum Required Distribution.  The Government says that you must remove at least that amount of money in that year from the IRA.  The reason for RMDs is so the Government can get some tax revenue from the tax deferred investment you made so many years ago.

Some people in this situation must take the RMDs yet they don’t need the money.  In many cases, they end up giving the money to charity and taking a charitable contribution deduction on their schedule A.  So they would take the RMD, pay tax on the distribution, give the money to charity, and get a tax deduction.  Typically, the tax you pay is more than what you save by taking the deduction.

Now there is a better way (for 2010 and 2011 tax years):

Instead of taking possession of your RMD, instead you can do a direct transfer, trustee to trustee  (IRA custodian to the Charity). This is a win win situation:  The charity gets the money, you do not pay tax on the RMD.  By the way, you also cannot “double dip” by taking a charitable contribution an schedule A.

So two key things: The money can’t go through you (to the charity) and You cannot take the charitable contribution deduction on Schedule A.

But that’s not all:

Also, you have until January 31, 2011 to do this for 2010.  Turns out that Congress got around to passing this so late in the year (December 18, by the time all was said and done), many people who could have done it had they known about it would have.  Instead, due to the uncertainty of the tax bills, many probably didn’t.

One last thing: You can contribute up to $100,000 per taxpayer from your IRA to your favorite charity.

Contact your Investment advisor, and ask him for the paperwork so you can make this happen.  If you are in this situation, everybody wins.

Tax Tip #1:  Organize Your Records for Your Tax Preparer

According to this blog:

Before you visit or drop off your documents to your tax prepared, you should have them arranged in some sort of order so you can make it easy for him/her to do your taxes.  Don’t be indignant and think that it’s his/her job to do that.  As one Accountant stated:  “You can do it yourself or you can pay me to do it.”

Don’t pay an accountant  $100 an hour to organize your tax records.  He’s just going to give it to a minimum wage clerk to do it anyway.  The exception would be that if you are a highly paid individual who would be foregoing many thousands of dollars in income just to organize your tax records, then having an accountant delegate that job to a clerk (and charge you an extra few hundred dollars) would be a good trade off.

This may seem obvious, but you’d be surprised by how many people do not organize their records and just give us bags or boxes of papers.  Organizing your records by yourself can save hundreds of dollars from your tax bill.  I slightly disagree with the exception he notes:  I believe that even a highly paid individual would do well to spend an hour organizing his records.

As I think of more ideas for you, I will include them here, so check back every so often.

In the meantime, you should begin to organize your records!

I am studying the impact of the new law, but I’ve picked out a few items that may impact you in 2010 and 2011:

Tax Rates:

• No Change.  Tax Rates for 2010 and 2011 will be 10%, 15%, 25%, 28%, 33%, and 35%
• Capital Gains Tax Rates: Remain unchanged through 2012.  Also, Dividends will be taxed at Capital Gains rates through 2012.

American Opportunity Credit:

This education credit has been extended through 2012.  This is a significant credit (worth up to $2,500) available to parents paying for their kids first 4 years of College.  It’s also significant since up to $1,000 is refundable to the Taxpayer.

What this means to you: If you are paying for kids in College (first four years) tell your Tax Professional to take advantage of this Credit.

Residential Energy Credit:

This credit was set to expire in 2010, however, it has been extended indefinitely.  However, after 2010, the maximum credit allowed per home will be limited to $500, of which only $200 can be for windows.

What this means to you: If you have any left over Christmas money, invest in the energy efficiency of your home this year when you can get a bigger tax credit, rather than next year when it will be significantly lower.

Payroll Tax Reduction:

Beginning in 2011 (and for only 2011), the old age portion of the employee’s Social Security withholding will be reduced from 6.2% to 4.2%.  The employer match will remain at 6.2%.  For self employed individuals, the rate will be reduced from 12.4% to 10.4%.

What this means to you: A person or family making $50,000 will save $1,000 in Social Security Tax next year. This averages almost $20 per week in additional spending money. You should consider investing this money in some sort of Tax deferred account, or increasing or contribution to your 401K.

There are other changes the new law brought about, but most of it was extending the tax rates for a year or two.  We will continue to study the law and continue to comment on how you might use it to reduce your family’s tax burden.

As you may be aware, there is a Lame Duck session of Congress and that session will determine tax policy for 2010.  It is amazing to me that Congress is so irresponsible as to not deal with budgets and tax policy for 2010 until the last month of the year.  While it is true that some companies do not have completed budgets until the last month of the year, these companies are always the worst run companies.  So basically Congress can compare itself to a poorly run company.  But I digress….

As I mentioned in an earlier post, AMT rates and rules will return to 2000 standards in 2010 (they expired in 2009).  But the worst part is that AMT is not the only part of the tax code that will revert to 2000 levels.  Here are other undecided tax policies that may affect you:

• Tax rates revert to higher levels.
• Return of the the “Marriage Penalty” affecting MFJ.
• Tax Credits will revert to lower levels or be eliminated (EIC, other Child credits)
• Capital Gains tax goes from 15% to 20%
• And as mentioned, AMT will ensnare more families- families not originally intended to be ensnared.

The New York Post generated a couple examples and showed that a married family with two children 17 and income between $50,000 and $71,000 will pay over $2,000 more in Federal Income tax if Congress does not act to change this.

Leaving aside the question of what is the proper amount of money people should pay in tax, the other problem is that I as a tax professional cannot advise you on what to do to minimize your tax bill.  Will the Bush era tax policies be extended?  Nobody knows.  The President wants them extended for all but the wealthiest Americans, but the wealthiest Americans generate 90% of the new jobs, so maybe they should be extended for everybody.  But the President and Congress doubled the National Debt over the past two years, and at some point, the amount of debt becomes important.  When will people have to pay more tax to reduce the deficit and bring down the debt?  Nobody in Washington has addressed these issues in the past two years, but they expect people to file their taxes correctly and on time.  Yet another case of “Do as I say, not as I do.”

The best guess is that the Bush era tax policy will be extended for 2010.  That means that the same rates, deductions, credits etc will be in place (actually will have been in place) during 2010 as were in place in 2009.  In December, most accountants will attend tax update classes, and be educated as to the revisions, and at that time, hopefully Congress and the President will have decided the Nation’s tax policy.

As an aside, if you think this procrastination is unprofessional (Juvenile?) you should call your representative and your two Senators and complain.