The election is over and there are still many unanswered questions regarding tax law, making it difficult to do tax planning for 2012 and beyond.
“You need to partner with a tax adviser,” says Rich Lundy, CPA, Director, Tax and Business Advisory Services with GBQ Partners LLC. “It’s difficult for the general population to stay up to date because a lot is still up in the air. It is not yet known when any potential changes will take effect and what the outcome will be, both in the short term and long term.”
Lundy says working with an adviser on year-end planning can result in potential permanent savings due to possible changes in tax rates.
Smart Business spoke with Lundy about the major tax issues impacting year-end planning for businesses and individuals.
How is the fiscal cliff affecting year-end tax planning?
Late in 2011, Congress couldn’t agree on spending cuts, so it put in automatic mechanisms to reduce expenditures. In addition, if nothing is done by the end of the year, tax rates will increase for almost everyone. There are major economic concerns over the impact of reduced government spending and increased tax rates going into effect at the same time. If Congress doesn’t act by the end of the year, the top tax rate would revert to 39.6 percent, up from the current 35 percent, and there would be increases in the lower brackets, as well.
President Barack Obama has proposed keeping the rates the same for the lower brackets — less than $200,000 of taxable income for individuals, or $250,000 for those married filing jointly. Tax rates currently range from 10 to 28 percent below those income levels. In a potentially higher tax rate environment, in general, individuals could benefit from maximizing income before tax rates increase.
Businesses, specifically C corporations, are currently subject to a maximum tax rate of 35 percent, one of the highest corporate tax rates in the world. The president has proposed reducing that rate to 28 percent, along with potentially curbing some business deductions. The strategy for a C corporation would be to try to defer deductions and/or income to some time in the future when rates may be lower.
What impact will the Medicare tax increase have on year-end planning?
There are two types of tax increases enacted by the health care reform in 2010 that take effect on Jan. 1, 2013. The first is on earned income: If you exceed the earned income limit of $200,000 for individuals or $250,000 for those married and filing jointly, there will be an additional 0.9 percent tax, increasing the Medicare tax rate from 1.45 to 2.35 percent. Those who will fall into this category in 2013 may want to consider taking an early bonus in 2012, or maximizing income before the end of the year if self employed.
The other tax is on unearned income, including interest, dividends, rental income, royalties, passive income and capital gains. This will be an additional 3.8 percent tax if you have income in these areas and exceed modified Adjusted Gross Income of $200,000 if single or $250,000 if married and filing jointly. Those whose modified AGI exceed these limits should consider accelerating these types of income into 2012, rather than deferring to 2013, to the extent possible.
What other areas of concern exist?
One is the capital gains tax. Currently, the long-term capital gains tax rate is 15 percent. In 2013, with no further action, rates could increase to as high as 25 percent. Many people are choosing to take their long-term gains now by selling stocks and bonds to generate long-term capital gains, and some who were already considering selling their businesses have moved the timeline up to this year. This is one of the most significant changes and an area where you can take action in your year-end planning to avoid those higher rates next year.
Another area of concern is qualified dividends, which are now taxed at 15 percent for higher- and middle-income taxpayers. If Congress does nothing, the phrase ‘qualified,’ which generally means that you’ve held the stock for 120 days, disappears from the tax code. The higher bracket could increase from 15 percent to 39.6 percent, the middle bracket from 15 to 28 or 33 percent and the lowest bracket from zero to 15 percent.
As noted earlier, the new Medicare tax on unearned income applies to interest, dividends and capital gains as well, so there would be an additional 3.8 percent tax for the upper-income individuals in this area. This could potentially triple the tax rate on qualified dividends. This is problematic because not only are dividends subject to double taxation, but many investors have invested in companies that are paying reasonable yields because they cannot get reasonable investment income from vehicles such as CDs and money market funds.
These expiring tax rates could wreak havoc on the stock market. There has been discussion about whether companies will unleash some of their cash before the end of the year in the form of dividends while the rate is still 15 percent. This could potentially impact stock valuations and large company behavior toward shareholders.
Finally, alternative minimum tax could hit an additional 33 million taxpayers if Congress does not implement a patch before the end of the year. The proposed two-year patch would restore exemptions to near 2011 levels, retroactive to the beginning of 2012. Because alternative minimum tax is not indexed for inflation, more and more people will be subject to it.
Rich Lundy, CPA, is Director, Tax and Business Advisory Services with GBQ Partners LLC. Reach him at (614) 947-5264 or firstname.lastname@example.org.
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