Q: I am retired and continue to do some part-time contract consulting. In 2010, I reported gross receipts from consulting of $4,200 on IRS schedule C. I also had $1,144 of business expenses on that form and had to pay $432 of self-employment tax. I was allowed to deduct half of the self-employment tax, or $216 on the front of my tax form. I contributed $4,200 to an IRA because that was my earned income. I am now told that you are supposed to reduce the contribution by the business expenses and the deduction for the self-employment tax and that I should pay a 6 percent penalty on the excess 2010 contribution. Also, the penalty continues for each year that I don’t remove the excess. But one option is apparently to treat the excess as a 2011 contribution. Do I need to tell Charles Schwab, who runs the account, that I am doing this? And how to I tell the IRS I want to do this?
A: The IRS form used to compute the penalty will allow you to report that you want the excess contribution from 2010 to apply to 2011. This is Form 5329, which you can obtain from the IRS website (www.irs.gov).
Your 2010 return will need to be amended to report the excess contribution on Part III of the Form 5329. Line 15 will show the excess, and line 17 will show the 6 percent penalty tax.
You should also file this form on your 2011 tax return. If you have enough 2011 compensation to permit the 2010 excess to be treated as contributed in 2011, you will use the Form 5329 to show that the 2010 excess will be a deemed 2011 contribution.
First, report the 2010 excess amount on line 9 of the 2011 form. On line 10 you will enter your allowed contribution for 2011. Because you say that you made no actual 2011 contributions, the maximum allowed will carry down to line 13.
On line 14, you will be able to show the 2010 excess as a deemed 2011 contribution. The mechanics of the form will have you compute the continuing excess 2010 contribution to be zero. This is because it is deemed to be an allowed 2011 contribution, and is therefore no longer an excess contribution.
The 2011 Form 5329 then shows zero excess contribution on line 16, and it is that line that is multiplied by the 6 percent penalty rate. So the penalty tax will apply only to 2010 provided you have enough cushion in 2011 to absorb the prior year excess contribution.
Q: I have just heard that a new 3.8 percent Obamacare tax will be imposed in 2013 on investment gains. Why is no one talking about this? Is there any way to avoid this?
A: I suppose it depends on what circles you run in, but this is often discussed by tax advisors. Unless repealed before it becomes effective, the tax will apply to unearned income, such as dividends, interest, rents and capital gains.
The tax will apply only to those who have adjusted gross income over $200,000, or $250,000 for married joint filers. So the tax will apply to 2 percent to 3 percent of individual return filers.
At current tax rates, the total tax on interest income could increase from a maximum of 35 percent to 38.8 percent, and the tax on qualified dividends and net capital gains could rise from 15 percent to 18.8 percent.
With no congressional action by 2013, the 2001 and 2003 tax cuts will expire, and the maximum rates could then rise to 43.4 percent for interest and all dividends, and to 23.8 percent for net capital gains.
One common misstatement about the new Medicare tax is that it will apply to the sale of a house. I have seen many statements that the sale of a $200,000 house, as an example, will now include a $7,600 (3.8 percent) tax.
As noted above, the 3.8 percent tax applies only to “high-income” individuals, and then only to reported gains. Taxpayers may still exclude as much as $250,000 of gain from the sale of a principal residence ($500,000 for qualifying joint filers).
Only high-income home sellers with gains above the exclusion will need to worry about the 3.8 percent tax.
James R. Hamill is the director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at jimhamill@rhcocpa.com.
