2012 Tax Planning for Fiscal Cliff

2012 Tax Planning for Fiscal Cliff

Now that the election is over, our federal government has to address the “Fiscal Cliff” created by the Budget Control Act of 2011.  The Fiscal Cliff involves several tax increases, the expiration of the Bush Era tax cuts, along with cuts in government spending.

Unless the Senate and the House come to a resolution, there are several tax provisions that will expire or be replaced after December 31, 2012.  These tax changes will have a significant impact on your individual income taxes, estate and gift taxes and taxes on businesses.

Without a resolution prior to the end of the year, below are some of the changes that will be made and some tips for your tax planning for 2012.

Individual Income Taxes
Below are the income tax provisions that will impact individuals after 2012. 

Individual Income Tax rates will increase, depending on your income level, to 15%, 28%, 31%, 36% and 39.6%. Current tax rates are 10%, 15%, 25%, 28%, 33% and 35%. 

The tax rates on capital gain will be increased to 15% and 20%.  Currently, the tax rate on capital gains is 0% or 15 %. 

Qualified dividends will be taxed at the ordinary income rate, which has a maximum rate of 39.6%.  Qualified dividends are currently taxed at 15%.

A 3.8% Medicare Contribution Tax will be implemented for married couples with an Adjusted Gross Income of $250,000 or more.  This is a tax on net investment income, which is interest, dividends, rental income and other passive income or non-wage income.

There will be an elimination of the payroll tax break.  For the past two years, the employee’s share of withholding taxes for Old Age and Survivors Disability Insurance (Social Security) was reduced from 6.2 % to 4.2 %.  On January 1, 2013, this rate goes back to 6.2 %.  

Typically when tax planning for the year end, the general rule is to defer income to another year and accelerate expenses into the current year.  For 2012, the advice is to accelerate income into this year, and maybe even accelerate expenses into this year.

One of the proposals presented by President Obama is a change in the itemized deductions for 2013, either by limiting the maximum amount of itemized deductions allowed or adjusting the amount of itemized deduction allowed based on income levels.  To take full advantage of the higher itemized deductions allowed, consider paying the expenses allowed as itemized deductions this year, such as property taxes, charitable contributions, etc.

To take advantage of the lower income tax rates in 2012, consider accelerating any wages, bonuses or other compensation which can be paid in 2012 to be actually paid in 2012.

It is recommended that you sell long-term gain assets, such as securities, which have increased in value to recognize the gain in 2012.  If you believe that the investment will continue to increase in value, the advice would be to sell the investment and then repurchase it to share in the future appreciation.  The limitations based on a “wash sale” apply to recognizing losses on a sale, but does not apply to recognizing gains.  

If you own C Corporation or S Corporation stock and the corporation has earnings and profits, it may be beneficial to pay dividends by the end of the year.  In 2012 qualified dividends are taxed at 15%.  In 2013 these same dividends will be taxed at ordinary income rates which could be as high as 39.6% and may be increased by the 3.8% Medicare Contribution Tax.
  
High income individuals may consider converting their interests in limited liability companies and partnerships to a corporation, which will convert the self-employment income or wages to another type of income.  For tax purposes, limited liability companies are typically taxed as a partnership.  Earnings from partnerships are usually treated as wages or self-employment income, which in 2013 will be subject to the additional 3.8% Medicare Contribution Tax.  If you have an S Corporation engaged in an active trade or business, you can still pay  yourself wages and then make a distribution of the remaining share of income from the S Corporation which would avoid the 3.8% Medicare Contribution Tax, since it would not be investment income.

Estate and Gift Taxes
For estates and gifts, there is a significant change.  Through the end of 2012 the maximum tax rate for estate and gift taxes is 35% and the exemption amount is $5,120,000.  This means that you are allowed to transfer by inheritance or by gift $5,120,000 in 2012 without any estate or gift tax.   

Unless the current rates are extended, in 2013 the estate and gift tax exemption drops to $1,000,000 in assets and estates with assets over $1,000,000 will have to pay taxes at a higher tax rate, with the maximum rate being 55%.  In addition, the generation skipping tax exemption that is currently at $5,120,000 will be dropped to $1,400,000. 

If you are considering making a substantial gift in the future, barring a change in the current legislation, it is in your best interests to make the gift in 2012.

The 3.8% Medicare Contribution Tax will also be applicable to earning of an estate and trust.  To avoid the additional tax on the estate or trust, plan on distributing as much of the estate or trust earnings in 2013 as possible.  
 
Business Taxes
For businesses, there are two changes that will impact current business owners.  One is the loss of bonus depreciation.  Currently there is a special 50% first year bonus depreciation allowance for the costs of qualified property which is placed in service by the end of the year.  This 50% first year bonus depreciation is eliminated in 2013.  

Section 179 allows a business to deduct the entire cost of qualified property in the first year in which it is placed into service instead of claiming a depreciation deduction over a number of years.  In 2012, Section 179 expense is allowed up to a maximum of $139,000 of qualified property placed into service.  In 2013, the dollar limitation is $25,000.  There is an obvious advantage to place as much personal property used in a trade or business, including software, into service in the year 2012.

Due to the generality of the information provided in this article, the information provided here may not be applicable in all situations.  No decisions should be made or any action taken without consulting with your professional tax advisor and should be based on sound financial planning principles.

Christopher G. Schultz is a partner in our Livonia office where he concentrates his practice on corporate and business law, commercial litigation and estate planning.  Additionally, Mr. Schultz is a Certified Public Accountant.  He can be reached at (734) 261-2400 or cschultz@cmda-law.com.