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 email@example.com.
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While the results of the presidential election have been determined, the tax landscape is less than settled. Absent any legislative changes, taxpayers are looking at significant modifications in federal taxation beginning in 2013.
“Taxpayers need to be aware of the changes and know how they will impact them. Year-end tax planning becomes critical,” says John T. Alfonsi, managing director at Cendrowski Corporate Advisors.
Smart Business spoke with Alfonsi about what business owners and individuals should know about the anticipated changes.
What are some of the changes individuals will be experiencing in 2013?
Plenty of changes will occur by virtue of the expiration of the Bush-era tax cuts primarily enacted by the Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs Growth Tax Relief Reconciliation Act of 2003. For starters, tax rates will revert back to the former brackets, with the top marginal rate rising from 35 percent to 39.6 percent. Capital gain rates will also change. Currently, long-term capital gains are taxed at a maximum rate of 15 percent. Beginning in 2013, that maximum rate goes up to 20 percent.
What about dividend income?
Dividend income is currently taxed at the same rate as long-term capital gains, or a maximum of 15 percent. All dividend income will be taxed at ordinary income rates beginning in 2013. Accordingly, individuals in the top tax bracket will see their dividend income go from being taxed at 15 percent to 39.6 percent.
Are tax rates the only thing affected?
No, deductions are impacted, as well. For example, overall itemized deductions are currently not subject to any limitations. Beginning in 2013, we revert back to prior law, where higher-income taxpayers must reduce their total itemized deductions by 3 percent of the amount in excess of a threshold amount of adjusted gross income; total itemized deductions cannot be reduced by more than 80 percent, however. Personal exemptions are another deduction that will be impacted. Currently, there are no restrictions on the amount of personal exemptions a taxpayer can deduct in arriving at taxable income. After 2012, however, personal exemptions will be limited for higher income taxpayers — the amount is reduced by 2.5 percent for each $2,500 by which the taxpayer’s adjusted gross income exceeds applicable thresholds.
Are there any new taxes individuals should be aware of?
Absolutely. There are two specific taxes higher income individuals need to consider. First, the employee portion of the hospital insurance payroll tax will increase by 0.9 percent — from 1.45 percent to 2.35 percent — on wages over $250,000 for married individuals and $200,000 for unmarried individuals. The employer portion will remain at 1.45 percent. The other new tax is the Medicare contribution tax on unearned income of higher-income individuals. This tax was enacted as part of the Patient Protection and Affordable Care Act, better known as ‘Obama Care.’ The tax is 3.8 percent on the lesser of an individual’s net investment income or the amount of adjusted gross income in excess of certain thresholds — $250,000 for married individuals and $200,000 for unmarried individuals. For purposes of this tax, investment income includes interest, dividends, and income and net gains from passive activities and ‘trader’ activities, such as hedge funds.
To illustrate the impact of these changes, let’s assume a married individual has an adjusted gross income of $700,000, which is made up of wages and salary of $500,000, dividend income of $100,000 and $100,000 long-term capital gain, both from investment partnerships. Further, assume the taxpayer has gross itemized deductions of $50,000 and four personal exemptions. Taxable income will increase by approximately $35,000 solely because of the limitation on itemized deductions and personal exemptions. The total federal income tax liability will increase from approximately $151,500 to $206,000 as a result of the higher tax brackets, dividend income being taxed at ordinary income rates and the new Medicare contribution tax on the dividend and long term capital gains income. This is a 36 percent increase in the federal income tax liability without any change in gross income. This also ignores the impact of the additional $2,250 hospital insurance payroll tax on the wages.
What can taxpayers do to minimize the potential tax increase?
Tax planning becomes important. Conventional wisdom suggests you should defer income and accelerate deductions. But in a period of increasing tax rates, there are no steadfast rules; each situation needs to be looked at individually. For example, with the higher tax rates in 2013, you may want to defer any charitable contributions from 2012 to 2013 as you get a potentially bigger benefit at the higher rate. But the taxpayer needs to consider the limitation on itemized deductions that will apply in 2013, but not in 2012. This ignores, of course, the impact of the alternative minimum tax, which presents its own set of issues, concerns and tax planning. Accelerating capital gains into 2012 may be a planning opportunity to take advantage of the 15 percent rate and avoid the Medicare contribution tax on such income.
Do you have any other tax planning tips?
Taxpayers looking to make significant gifts as part of their estate plan should consider taking advantage of the $5 million lifetime gift exclusion, which expires at the end of 2012. Beginning in 2013, the lifetime gift tax exclusion decreases to $1 million. Further, estate and gift tax rates are scheduled to increase from a maximum of 35 percent to 55 percent. Of course, all of this becomes moot if new legislation is enacted to avoid the ‘fiscal cliff’ we are facing.
John T. Alfonsi is managing director at Cendrowski Corporate Advisors. Reach him at (866) 717-1607 or firstname.lastname@example.org.
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Tax planning is even more uncertain and complex this year because of the number of tax changes scheduled to take place when the calendar flips to 2013.
“The expiration of the Bush-era tax cuts, the imposition of the Medicare surtax in 2013, whether or not certain tax provisions will be extended and President Obama’s proposed extension of the 36 percent tax bracket to married couples earning more than $250,000 adds a level of uncertainty to year-end tax planning not seen in years,” says Tom Tyler, partner with Crowe Horwath LLP.
Smart Business spoke with Tyler about potential tax changes and what business owners should do in preparation.
What are the Bush-era tax cuts, and what would be the effect of their expiration?
President George W. Bush cut individual tax rates to 10 percent, 15 percent, 28 percent, 33 percent and 35 percent, depending on a taxpayer’s taxable income, and reduced to 15 percent the rates for qualified dividends and capital gains. Taxpayers in the 10 percent and 15 percent brackets pay zero percent on qualified dividends and capital gains.
If Congress does not extend these rates beyond 2012, the new tax rates beginning in 2013 would be 15 percent, 28 percent, 31 percent, 36 percent and 39.6 percent. Dividends would no longer receive preferential tax treatment; instead, they would be taxed at ordinary income rates. Capital gains would be taxed at 20 percent — 10 percent for taxpayers in the 15 percent tax bracket.
In addition, President Obama has proposed extending the 36 percent tax bracket to adjusted gross incomes greater than $200,000 and $250,000 for single filers and joint filers, respectively. Note that adjusted gross income is determined before personal exemptions and itemized deductions; taxable income is determined after personal exemptions and itemized deductions. Absent the Obama changes, the 36 percent bracket would start at taxable income of $183,250 and $223,050, for single and joint filers, respectively.
What other tax changes are on the way in 2013?
The Patient Protection and Affordable Care Act added a 3.8 percent Medicare surtax beginning in 2013 for higher-income taxpayers. The tax applies to the lesser of a taxpayer’s net investment income or the amount by which the taxpayer’s modified adjusted gross income — adjusted gross income with foreign income added back — exceeds $200,000 in the case of a single filer or $250,000 in the case of a joint filer. Net investment income includes interest, dividends, royalties, rents, capital gains and passive income from trade or business activities. Higher income individuals with wages or self-employment income exceeding $200,000 for single filers and $250,000 for joint filers will see an increase in their Medicare tax rate from 1.45 percent to 2.35 percent.
For the past two years, the employee share of Old Age, Survivors, and Disability Insurance (OASDI) has been reduced from 6.2 percent to 4.2 percent. This rate reduction is scheduled to expire at year-end and will return to 6.2 percent. Employers that typically pay bonuses after year-end should consider accelerating the payment of those bonuses into 2012 for those employees below the Social Security wage base of $110,100.
Any other steps people should take before the tax rates change?
With respect to the tax rate increases and Medicare surtax, individuals might want to consider selling in 2012 appreciated capital assets that would generate long-term capital gains to take advantage of the 15 percent tax rate — zero percent for those in the 10 percent or 15 percent bracket. Loss assets could be held and sold in 2013 when the loss could be deducted at higher rates and result in increased savings.
If an individual controls a C corporation, consider distributing dividends from the corporation in 2012 instead of 2013, when the maximum rate on dividends is 15 percent instead of a potential rate of 43.4 percent — 39.6 percent plus 3.8 percent Medicare surtax. An S corporation that was formerly a C corporation and is considering distributing former C corporation earnings and profits could do so in 2012 to take advantage of the 15 percent tax rate on dividends.
Taxpayers also might want to consider repositioning their investment portfolios in light of these changes. Higher tax rates make tax-exempt investments more appealing. A shift away from dividend-paying stocks to nondividend paying stocks makes tax sense given the expiration of the favorable tax rate on dividends and the application of the 3.8 percent Medicare surtax to dividend income in 2013.
These tax saving ideas should be considered just one tenet of an individual’s overall investment plan.
Are deductions and exemptions going to change as well?
Unless extended by Congress, personal exemptions and itemized deductions will be subject to a phase-out beginning in 2013. Personal exemptions will begin to phase out at $267,200 of adjusted gross income for joint filers and $178,150 for single filers. Itemized deductions will be reduced by 3 percent of the amount adjusted gross income exceeds a threshold, projected at $178,150 for 2013.
Another uncertainty is the alternative minimum tax (AMT) exemption. Without congressional action, the exemption for 2012 would be $45,000 for joint filers and $33,750 for single filers. However, we are hopeful that an AMT ‘patch’ will be passed prior to year-end and increase the exemption. Last year’s exemption for joint filers was $74,450.
Tom Tyler is a partner with Crowe Horwath LLP. Reach him at (214) 777-5250 or email@example.com.
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Tax planning is especially complex this year given the turbulent political environment and a litany of tax laws due to expire at the end of 2012. From bonus depreciation to capital gains tax rates, if Congress fails to act and these provisions and others are allowed to expire, taxpayers could carry a significantly heavier financial burden in 2013.
“We know that tax laws are going to change, but we’re just not sure how,” says Cathy Goldsticker, CPA, member, tax services, at Brown Smith Wallace, St. Louis, Mo.
This year, more than ever, it is critical that businesses/business owners consult with their tax advisers as early as possible to discuss the what-ifs so they are prepared in December when we have a better idea of what 2013 tax law will bring, she says.
“All you can do with this level of uncertainty is plan, plan, plan,” says Robin Bell, CPA, member, tax services, at Brown Smith Wallace. Businesses and individuals should have several options depending on the outcome of the election.
Smart Business spoke with Goldsticker and Bell about tax provisions due to expire in 2012, and how business owners can best prepare and be flexible in light of the uncertain tax environment.
What measures can business owners take given tax law uncertainty?
Businesses that have not yet met their Section 179 threshold 2012 of $560,000 can invest in qualifying equipment and furniture so they can take the full write-off this year. Until the calendar year turns, the bonus depreciation of 50 percent still applies, and we’re not sure what will happen to this tax advantage next year.
Along the same lines, consider taking advantage of the current 15-year depreciation rate on qualified leasehold improvements, which fall into the three categories of commercial, retail and restaurant. This could roll back to the traditional 39-year depreciation tax write-off if the provision is not extended for 2013.
What could happen to the current low capital gains and dividend tax rates that are due to expire in 2012?
If nothing is done to extend current tax rates into 2013, the existing lower capital gains rate will expire. The 15 percent extended tax rate bracket changes to a 20 percent tax rate. Dividend income reverts from a 15 percent tax rate to a taxpayer’s ordinary income tax rate, which could be as high as 39 percent.
For business planning purposes, it may make sense to pay out dividends, if your corporation has accumulated earnings and profits, before the end of the year so those are taxed at the current 15 percent rate.
A potential capital gains and dividend tax rate hike could drastically affect retirement and investment planning, as well. Individuals may want to reconsider their investment strategy in dividend-paying stocks and choose exempt or fixed-income bonds, depending on projected rates of return.
What is known for certain about the 2013 tax situation?
Tax rates will not decrease, but it is not known how much they may increase or if possibly they may stay the same. That depends on how tax legislation shakes out at the end of 2012 following the presidential election and the decisions that Congress makes before new legislation starts during the lame duck session or afterward.
What we do know for certain is that the Medicare surtax is current law as part of the Patient Protection and Affordable Care Act. This 3.8 percent tax on net investment income will be imposed starting with the 2013 tax year on the lesser of an individual’s net investment income for the tax year or the amount by which their modified gross income exceeds the threshold amount that tax year — $250,000 for joint filers, $125,000 for married filing separate and $200,000 for all other filers. Essentially, this is a double tax that applies to individuals since this is a non-deductible tax.
Additionally, the 2 percent decrease to the Federal Insurance Contributions Act (FICA) rate that has been in effect for the past two years expires on Dec. 31, 2012, restoring the rate to 6.2 percent on wages and self-employment income. This will affect the take-home pay of all employees and owners.
For closely held businesses, it is important to consider salary management — look at payments and strategize the source of those payments in the most tax-efficient way.
Finally, the 3 percent ‘haircut’ for itemized deductions and personal exemptions is also set to expire in 2012. Bear in mind that itemized deductions and exemptions are phased out as income increases, so taxpayers will not get the benefits of all of their deductions as they have in the recent past. This calls for income management; if your income will increase in 2013, that may disallow some of your tax benefits and, theoretically, could put you in a higher tax bracket.
What additional tax provisions should individuals keep on the radar as they plan for 2012 and beyond?
For those taking advantage of the Refundable Alternative Minimum Tax (AMT) credit, this is set to expire in 2012. Also, the $1,000 child credit will revert to $500 if the provision is not extended.
Beyond these provisions, there is a laundry list of tax law changes that could occur in 2013 if there is no tax bill passed in 2012 or early 2013. We know there will be at least some change. To know what these changes will be, we need to see how the tax structure shakes out after the election and final congressional session of 2012. That said, the best way for business owners and their families to prepare is to plan carefully, including working out several tax scenarios. Then, wait to act until there is a clearer picture of 2013 tax legislation.
Last but not least, remember, there is an opportunity to transfer significant family wealth without incurring gift tax before the end of the year, and those opportunities might go away if the estate/gift tax structure is not extended.
Cathy Goldsticker, CPA, is a member, tax services, at Brown Smith Wallace LLC, St. Louis, MO. Reach her at firstname.lastname@example.org or (314) 983-1274.
Robin Bell, CPA, is a member, tax services, at Brown Smith Wallace. Reach her at email@example.com or (314) 983-1217.
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With year-end tax season in full swing, a cloud of uncertainty hovers over businesses. Forecasting what 2013 will bring in terms of tax rates and legislation is difficult because of the impending presidential election and the unknowns about whether the Bush-era tax cuts will be extended.
What will happen to tax rates in 2013? How could estate planning be affected? Is now the time for your business to buy equipment?
“This year, the traditional planning techniques of deferring income and accelerating deductions may not be appropriate, depending on what happens with tax rates,” says Michael R. Viens, director, Tax Strategies, at Kreischer Miller, Horsham, Pa.
Viens recommends businesses plan early but hold off on executing any specific plan until the post-election dust settles and Congress gives some indication of its direction concerning late 2012 or early 2013 tax legislation.
Smart Business spoke with Viens about how businesses can best prepare and position their organizations to be flexible in light of the uncertain political and economic climate.
How is this year different in terms of tax planning?
A key concern is tax rates and whether they will increase in 2013. If nothing happens legislatively by year-end, tax rates are scheduled to increase, impacting a number of events. Traditional business tax strategy focuses on deferring income and accelerating deductions, keeping as much cash in the business as possible. But such a strategy, if employed this year, may create higher taxable income in 2013, with the potential for a higher tax bite that could more than offset 2012 tax savings. Once the election is over, we should have clearer indications as to the likely tax regime in 2013 and beyond and will be in a better position to make decisions regarding implementation of specific tax planning initiatives.
Start planning now. Work through the what-ifs with your advisers, but wait before pulling the trigger until after the election.
Is now a good time to purchase equipment?
The purchase of appropriate qualifying equipment is a common year-end activity for businesses that wish to take advantage of the value of bonus-depreciation opportunities that allow an immediate 50 percent write-off, and a Section 179 expense deduction that allows deduction of the full amount of the purchase price of the equipment, up to $139,000, in the year in which it was purchased and placed in service. Bonus-depreciation provisions expire Dec. 31, 2012, and the Section 179 deduction is scheduled to revert to $25,000 for tax years beginning in 2013, unless extended.
With equipment purchases, economics should drive the decision, with tax impact being secondary. If the equipment is important and acquiring it today means the business will be in a better position than it would be buying it in January, purchasing now likely should win the day. But all things being equal, a purchase in December versus January may be worth considering once it is understood what tax deductions and rates will apply in 2013.
How might an equipment purchase in 2012 be more beneficial than in 2013 if the current tax structure is not continued?
Say a business purchases qualifying equipment for $1 million and places it in service in December 2012. It immediately gets a $500,000 tax deduction in 2012 per the 50 percent bonus depreciation rule and may also receive normal first-year depreciation for another $100,000. That equals a $600,000 deduction in 2012. And with a 35 percent tax rate, the tax savings is $210,000, resulting in a net short-term cash outlay for the equipment at $790,000.
If this purchase is deferred until January 2013 with no bonus depreciation and a new 40 percent tax rate, the business may save in the short term only $80,000 in cash rather than $210,000. However, due to subsequent depreciation, the business would realize a total of $240,000 in tax savings on the same $600,000 deduction that would be otherwise accelerated into 2012.
The business should weigh the longer-term $30,000 tax savings from deferring the equipment purchase into 2013 against an earlier short-term tax savings. The choice involves tradeoffs — short-term cash flow versus the present value of longer-term higher tax savings. Without knowing what 2013 will bring, planning for both scenarios is key.
How should businesses proceed with succession planning given tax law uncertainty?
Estate taxes are of importance to business owners in transferring ownership to the next generation, and there is uncertainty regarding those provisions. There are currently opportunities to transfer significant family wealth without incurring gift tax due to historically high lifetime gift exemption levels. But this could go away if the estate/gift tax structure is not extended. Businesses transferring ownership should discuss opportunities now with an attorney and their tax adviser.
What traditional year-end tax planning techniques still apply, regardless of what the tax law brings?
Address safe harbors to avoid underpayment penalties. Because many businesses are seeing 2012 earnings that are more robust than in 2011, a prior year-based 100 or 110 percent (applicable for higher income taxpayers) safe harbor comprised of withholding and/or estimated tax payments may be an easy answer. A business with a tax liability of $100,000 in 2011 could use a $110,000 safe harbor and make up a shortfall when tax returns are due next April.
What planning strategy can business owners adopt to prepare for unknown 2013 outcomes?
Develop a Plan A and Plan B, working out how your business will react if tax law continues as is, and what decisions will be implemented if the current tax opportunities and tax rates change. Depending on the position of the business and owner circumstances, this year may require a more robust planning process than in the past, which is a good reason to enlist an experienced accountant and begin the tax-planning dialogue early.
Michael R. Viens is director, Tax Strategies, at Kreischer Miller, Horsham, Pa. Reach him at (215) 441-4600 or firstname.lastname@example.org.
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