2012 Year End Income Tax Planning Strategies
Each year we acknowledge that year-end income tax planning is a challenge, which challenge has been, in recent years, compounded by the uncertainty over what the tax laws will be in the future. That is certainly the case this year.
It is quite likely that tax rates will be higher in 2013 as compared to 2012, at least for some taxpayers. Unless Congress acts, the ordinary income tax rates will increase for all individuals and tax-paying trusts with the top income tax rates for those taxpayers moving from 35% to 39.6%, more individuals will be snared by alternative minimum taxes, various deductions and credits will expire, the 15% tax rate currently applicable to dividend income and to long-term capital gains will increase to 39.6% and 20%, respectively, and unearned income of those single or married taxpayers with modified adjusted gross income of $200,000 or $250,000, respectively, will be subject to a 3.8% Medicare contribution tax under the Health Care and Education Reconciliation Act of 2010 (fondly known as Obamacare).
Traditional year-end tax planning was based upon the primary objective of deferring tax liabilities. The tactics employed included the acceleration of tax deductions and credits and the deferral of taxable income. Our year-end tax planning Client Alerts consisted primarily of checklists of opportunities used to achieve the tax liability postponement objective.
For 2012, however, a complete reversal of such tactics may be appropriate for those clients that may be facing the higher rates and new taxes in 2013 and beyond. Such taxpayers may want to accelerate taxable income into this year and to defer deductions and credits into future years.
The acceleration of income can be achieved through a variety of initiatives, depending upon particular circumstances, including:
- Arrange for prepayment of unearned income to taxpayer, including interest, dividends (including special or extraordinary distributions), royalties and rents or gain from sale of assets.
- Election out of installment sale treatment for gain derived from 2012 sale of assets, or effectuating taxable dispositions (including gift transfers) of installment sale instruments that were received from asset sales that were reported prior to 2012.
- An advancement of future compensatory bonuses into 2012.
- Harvest gains from portfolio investments, especially if a disposition of such assets in the next several years was already anticipated.
- Conversion of traditional IRA's to Roth IRA's.
- Acceleration of distributions from qualified plans.
- Exercise non-qualified stock options.
- Taxable liquidations of closely held entities.
The deferral of deductions and credits could be effectuated by delaying the related payments (or, as to accrual basis taxpayers, the incurrence) of the deductible or creditable items into next year. As to depreciable assets that were acquired in 2012, taxpayers should consider not claiming any available IRC §179 deductions, and, instead, depreciating the cost of those assets in future years.
Some of the proposals that are circulating in Washington include the limiting of itemized deductions effective for tax years beginning after 2012. Taxpayers that are contemplating sizeable charitable contributions should consider making those contributions in 2012, notwithstanding the tax rate differential described above.
These strategies must, of course, be considered carefully in light of the precise circumstances of each taxpayer. Taxpayers that do not expect to be subject to the higher tax rates or the new taxes may wish to employ the traditional year-end planning techniques that have been identified in prior Client Alerts. As suggested above, year-end tax planning for 2012 may be somewhat more complex for some taxpayers than is typical.