As it stands, the Bush tax cuts will expire, the temporary payroll tax cut will end, and unemployment benefits will be substantially curtailed at the end of 2012.
Expiration of Bush tax cuts will mean an increase in tax rates for investment income, estates and gifts, and earnings at all levels.
· Specifically, the existing 10% bracket will be replaced by a "new" lowest 15% bracket. The existing 25% bracket will become a 28% bracket; the existing 28% bracket will become a new 31% bracket; the existing 33% bracket will be replaced by the 36% bracket; and the existing 35% bracket will be replaced by the 39.6% bracket.
· The capital gains tax rate will increase from 15% to 20% and qualified dividends will be taxed at ordinary tax rates.
· The marriage penalty for joint filers will come back.
· The phase out rule for personal exemptions will be back.
· The value of the child credit will drop from $1,000 to $500.
· The AMT exemption amount will drop substantially.
· The 100% expensing levels will drop substantially as well.
· The estate and gift tax exemptions for 2012 rose to $5.12 million in 2012. That exemption is scheduled to drop to $1 million in 2013, and the estate and gift tax rates will increase from 35% to 55%.
The Social Security payroll tax will go back to 6.2% from current 4.2%.
Additionally new Medicare taxes enacted as part of Obama’s health care initiative will begin next year.
· Higher income taxpayers will be subject to an additional .9% HI tax on earned income (hospital insurance tax); on wages in excess of the threshold amount and net earnings from self-employment (NEFSE) in excess of the threshold amount ($200,000 single, $250,000 for joint filers).
· Higher income taxpayers will be subject to a new 3.8% unearned income Medicare contributions tax (UIMCT) on net investment income in excess of a threshold amount ($200,000 single, $250,000 for joint filers).
· Net investment income is defined as the excess of the sum of the following items less deductions properly allocable to such items:
o Gross income from interest, dividends, annuities, royalties, and rents, other than such income derived in the ordinary course of a trade or business to which the UIMCT tax does not apply;
o Income from a trade or business to which the UIMCT tax applies;
o Net gain (to the extent taken into account in computing taxable income) attributable to the disposition of property other than property held in a trade or business to which the UIMCT does not apply
o Business income from an activity that is passive with respect to the taxpayer is considered investment income for purposes of the UIMCT.
· Distributions from certain retirement plans are excluded from net investment income (Qualified pension, profit-sharing, and stock bonus plans, qualified annuity plans, IRAs, Roth IRAs and Deferred compensation plans of state and local governments and tax-exempt organizations)
Obviously this makes tax planning challenging and uncertain. Despite this, taxpayers should consider the possibility of implementing the following tax planning techniques to the extent that they can:
· Income recognition and deferral planning (structure transactions that result in tax-exempt or tax-deferred income, consider investing in growth stocks rather than dividend income stocks)
· Capital gain planning (Consider installment reporting where appropriate, or electing out of installment reporting for 2012)
· Retirement income planning (distributions from retirement plans are not subject to the HI tax or UIMCT, but they do increase MAGI which may increase investment income subject to the tax).
· Passive activity loss planning (Classifying income as passive is generally advantageous for taxpayers with sufficient passive losses to offset the passive income).
· Estate planning (Consider investing in tax exempt and tax-deferred investments, consider distributing net investment income to beneficiaries who have a higher threshold and lower net investment income).
It is unclear if Congress will elect to extend all, some or none of the expiring tax breaks before year end.
Unfortunately, if we do see changes, they will probably come in a last minute scramble during the last two months of the year.
Depending on your view about the future of tax rates, we can help you look at your tax situation, and consider all of the options available to you. Any decisions should be made based on economic considerations first - and tax implications second. Now more than ever, it is important to look closely at income tax planning. It is also critical to make sure that you are also considering any applicable estate tax planning! Please contact us to plan for your tax future!
Ashley Quinn, CPAs and Consultants, Ltd.