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Year End Tax Plan

Year-end tax planning is particularly challenging this year because of the uncertainty surrounding the Federal income tax. President Obama and a bi-partisan Congress are having difficulties agreeing on what action should be taken (or not taken) regarding Bush-era tax cuts that are set to expire at the end of 2012. In addition, healthcare reform brings with it new tax provisions intended to fund the changes in the law that begin to become effective in 2013. These tax changes coupled with significant federal spending cuts that have been written into law are known as the economy’s “fiscal cliff.”

If Congress and the President fail to take action, it will mean the following:

  • The highest income tax bracket for individuals will increase from 35% to 39.6%.
  • The tax on long-term capital gains will increase from 15% to 20% (0% to 10% for lower-income taxpayers).
  • The tax on qualified dividends will increase from 15% to the taxpayer’s ordinary income tax rate.
  • The 2% payroll tax cut for employees (and self-employed individuals) will expire.
  • The Medicare tax rate for individuals with wages or self-employment income over $200,000 ($250,000 for joint filers) will increase by .9% from 1.45% to 2.35%.
  • A new Medicare surtax of 3.8% on net investment income will apply to taxpayers with adjusted gross income (AGI) over $200,000 ($250,000 for joint filers).
  • The estate tax rate will increase from 35% to 55% and the gift and estate tax exemption will decrease from $5,120,000 to $1,000,000 per individual. In addition, portability of the estate tax exemption is set to expire.
  • The child tax credit will decrease from $1,000 to $500 per child.
  • The child and dependent care credit will decrease from $3,000 to $2,400 for taxpayers with one

    dependent and $6,000 to $4,800 for taxpayers with two or more.

  • The limitation on personal exemptions and itemized deductions will be reinstated so that higher- income taxpayers will lose some of the benefit of these items.
  • The maximum Internal Revenue Code Section 179 deduction will return to $25,000 and the limit of qualified capital expenditures placed in service during the year is reduced to $200,000.
  • Bonus depreciation will be eliminated.
  • The limit on employer-sponsored medical flexible spending accounts (FSAs) will be reduced to $2,500.

These changes would likely have a significant impact on most taxpayers. While the details may remain uncertain, it is still essential to be prepared. The following are viable planning options to consider:

  • Accelerate income or defer deductions (for example, collect a year-end bonus during December 2012 as opposed to January 2013 to avoid the payroll tax and income tax rate increases).
  • Work closely with your investment advisor to determine if it makes sense to sell appreciated securities in 2012 to take advantage of the lower rate.
  • If you plan to sell your business, aim for a close date in 2012 to take advantage of the lower rates on capital gains. Be aware that installment sale payments received in 2013 will be taxed at the higher income tax rates.
  • If you plan to sell your home at a gain greater than the $500,000 home exclusion (for married taxpayers filing a joint return), aim for a close date in 2012.
  • Place in service machinery and equipment in 2012 to benefit from the 50% bonus depreciation while it still applies and/or the increased amount (up to $139,000) of Section 179 expensing.
  • Qualified corporations should consider accelerating dividend payments to 2012 to allow the recipient to claim the beneficial rate on qualified dividends.
  • Consider adjusting your income tax withholding and/or estimated payments in early 2013 to account for any changes you anticipate in your personal tax situation (for example, loss of itemized deductions, child and dependent care credits, personal exemptions, or increase in Medicare taxes).
  • Plan to defer tax on investments by using tax-deferred annuities, retirement plans, traditional and Roth IRAs, and 529 college savings plans.
  • Contemplate converting a traditional IRA to a Roth IRA before the income tax rates increase.
  • Examine your income-producing activities to determine if any can be established as material or active participation to avoid the new 3.8% Medicare surtax on net investment income. Keep in mind that shifting income from passive to active could suspend other passive losses.
  • Consider investing in tax-exempt bonds or similar investments which are not subject to the new 3.8% Medicare surtax.
  • Estates and trusts should think about distributing income when beneficiaries’ income is below the level that will be subject to the new 3.8% Medicare surtax.

    We tried to outline the major tax changes taking effect next year and to list several tax planning strategies to deal with them. Each taxpayer’s situation is different and not every strategy is a good fit for everyone. Please contact us with any questions you may have or to speak with us about your tax plan.