2012 - 2013 Tax Planning

Taxes are going to be a major issue for the rest of 2012 and for much of 2013. On January 1, 2013, the country faces what Federal Reserve Chairman Ben Bernanke has called a "fiscal cliff," resulting from the expiration of the Bush-era tax cuts and the automatic across-the-board cuts in government spending. Added to these events is the uncertainty over the alternative minimum tax and the tax breaks known collectively asthe "tax extenders."

If Congress does not act, the Bush-era tax cuts will expire. The resulting sharp income tax rate increase on January 1 will hit most Americans, not just those earning more than $250,000. With the Supreme Court upholding the health care law, a 3.8 percent Medicare tax on net investment income will go into effect on top of the increase in income tax rates. In addition, the automatic budget cuts of $1.2 trillion will begin to take effect; the combination of all of these is commonly referred to as the "fiscal cliff." Many economists predict that the failure to address the fiscal cliff could throw the economy back into a recession.

Individual Tax

  • The highest income tax bracket for married taxpayers filing a joint return will increase to 39.6 percent from the current 35 percent for taxable income in excess of $379,650. Note the 39.6 percent rate does not include the 3.8 percent Medicare tax discussed above. President Obama has proposed extending the tax cuts for married taxpayers with less than $250,000 in annual income or single filers with less than $200,000 in annual income, but not for taxpayers above that income level.
  • The tax on long-term capital gains will increase to 20 percent from 15 percent.
  • The tax on qualified dividends will increase to ordinary income rates (top rate of 39.6 percent) from 15 percent. President Obama has proposed maintaining the 15% long-term capital gain rate for taxpayers with income less than $250,000 (married filing jointly). He has also proposed retaining the 15% dividend rate for taxpayers with income less than $250,000.
  • The 2 percent payroll tax cut will expire (reducing take-home pay for employees and increasing self-employment tax for qualifying individuals). The employer payroll tax rate remains at 7.65 percent (both Social Security and Medicare). 
  • The Medicare rate for individuals with gross wages (or self-employment income) in excess of $200,000 will increase to 2.35 percent from 1.45 percent. 
  • The estate tax rate will revert to 55 percent and the exemption amount will decrease to $1 million from $5 million. 
  • The child tax credit will decrease to $500 from $1,000; phasing out when incomes exceed $110,000 (married, filing joint returns). 
  • The child and dependent care credit decreases to $2,400 per dependent (maximum $4,800) from $3,000 (maximum, $6,000) per dependent. 
  • The personal exemption phase-out and Pease (limitation on itemized deductions) provisions will be reinstated to their original levels, projected to be $174,750 for single taxpayers and $261,650 for married filing joint taxpayers. This means taxpayers with adjusted gross income (AGI) in excess of these amounts will lose the benefit of their personal exemptions and their itemized deductions will once again be limited. President Obama made two proposals during the campaign: eliminate itemized deductions for housing, healthcare, retirement and childcare for individuals with more than $1 million in annual income, and limit the benefit of itemized deductions to 28% for taxpayers in higher rate brackets. 
  • Taxpayers currently must pay the greater of regular income tax or the alternative minimum tax (AMT), which has a top tax rate of 28%. President Obama's proposed tax plan would permanently extend the AMT and indexes AMT exemption for inflation. It also creates the "Buffet rule", which states that households earning more than $1 million per year would pay a minimum 30% income tax rate. 
  • The current Internal Revenue Code (IRC) section 179 deduction will revert to $25,000, with a cap on qualified expenses of $200,000. 
  • Bonus depreciation will be eliminated.
These changes will have a significant impact on taxpayers in 2013. For example, a taxpayer with taxable income of $1 million, 50 percent of which is qualified dividends, will see their tax liability increase to $415,000 from $250,000. 
Strategies to mitigate the impact of these tax increases 
  • Plan how much, if any, capital gains on appreciated securities you would want to recognize in 2012. 
  • If you are planning to sell your business, try to close the sale in 2012 to take advantage of the lower capital gains tax rate.
  • Remember gain from installment sale payments is taxed in the year received; payments received in 2013 on a 2012 sale would be subject to the higher capital gains rate. However, if you opt out of the installment method, all the gain would be taxed in 2012 at the lower rate regardless of when the payments are received. 
  • Place in service capital improvements in 2012 to take advantage of 50 percent bonus depreciation and $139,000 IRCsection 179 deductions.
  • Consider accelerating income to 2012 to take advantage of the lower rates. You may want to defer deductions until 2013 to offset the higher rates in that year. 
  • Qualified corporations should consider accelerating dividend payments to 2012 to take advantage of the last year for the lower tax rate. 
  • Contemplate adjusting your income tax withholding and/or estimated tax payments in early 2013 to account for any loss of itemized deductions, child and child care credits, and personal exemptions. 
  • Consider converting anIRA t oa Roth IRA before income tax rates increase.




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