Federal Tax Provisions for Individuals and Businesses

Tax planning can reduce estate taxes.
The reduced individual income tax rates created by the Jobs and Growth Tax Relief Reconciliation Act of 2003, Unemployment Insurance Reauthorization and 2010 Tax Act, are scheduled to sunset after 2012.
The gift tax and GST tax rate is 35% through 2012 and will increase.
When combined with estate planning and gift planning techniques, such as a GRAT, there was the opportunity to transfer wealth to family members.

For more information on income tax rates, the gift tax, and estate taxes, contact our tax services group who can assist with estate planning and tax planning.

A A A

2013 Personal Tax Guide - 2012 Tax Planning Goals

Contact: Marie Arrigo

December 04, 2012

NEW - Click to view the 2014 PERSONAL TAX GUIDE

Marie ArrigoEISNERAMPER TAX PLANNING TIPS ARE AVAILABLE. 

We trust you'll find our guide useful and informative. As always, our EisnerAmper tax professionals are available to discuss any tax planning opportunities in the guide.

Best Regards,
Marie Arrigo signature - white
Marie Arrigo
Editor in Chief
EisnerAmper LLP

In this first chapter of the 2013 Tax Guide, EisnerAmper provides tax tips for 2012 filers. 

In addition to saving income taxes for the current and future years, tax planning can reduce eventual estate taxes, maximize the amount of funds you will have available for retirement, reduce the cost of educating your children, and assist you in managing your cash flow to help you meet your financial objectives. This year, specifically, there is a great deal of uncertainty with the potential sunset of many tax provisions.


A Real Cliff Hanger: Year-End Tax Planning Opportunities in the Face of Uncertainty 

Introduction

This publication highlights certain significant 2012 federal tax provisions for individuals and businesses that will expire or be curtailed on December 31, 2012. We encourage you to consider these provisions, taking into account your own facts and circumstances, and contact your tax professional for guidance. The time to act is now; there are certain tax planning opportunities and benefits that you can avail yourself of before the applicable provisions expire.

Considering the uncertainty regarding post-2012 federal tax policies and tax provisions for individuals and businesses, effective tax planning will continue to be challenging. The May 2012 U.S. Congressional Budget Office report stated that the economy would shrink by 1.3% in the first half of 2013 as a result of impending tax rate increases and more than $100 billion in automatic spending cuts occurring in the Pentagon and other U.S. government agency budgets. As a result, consumers will have less disposable funds to spend, and the defense and domestic spending cuts will decrease U.S. production and manufacturing. These two economic conditions comprise what are referred to by the government and the media as the "fiscal cliff." Under both conditions, U.S. GDP after 2012 is predicted to be negatively impacted. Further, there is a lack of guidance regarding long-term Congressional action on the U.S. budget and debt limits, another matter that will impact long-term tax planning. The ability to effectively utilize future tax provisions post-2012 is very uncertain.

The current political rhetoric includes many proposals relating to the structure of the federal income tax and the tax rates to be applied to various types of income. Certain proposals call for increases in current federal tax rates, while others seek a reduction in those rates. Although almost everyone seems to be in agreement that the Internal Revenue Code is too complex and contains so-called loopholes unfairly favoring wealthy individuals and certain sectors of our economy, there is no agreement on a replacement structure or significant changes in the existing structure. Unfortunately, there is the possibility that the present gridlocked situation may continue after the November election. The outcome of the election has resulted in the status-quo: The Republicans still control the House, the Democrats still control the Senate and President Obama returns to the White House for another four years. While there is impetus to address the impending fiscal cliff before the end of the year, and in fact, we have recently seen increased discussions between Congress and the President, it is possible that nothing will occur. It is also possible that Congress may act sometime in 2013, and such legislation may be retroactive to January 1, 2013. However, at this time, nobody can reliably predict future legislation. If no Congressional agreement is reached, then on January 1, 2013 there will be an automatic increase in federal taxes for most readers of this publication and government spending will be curtailed.

Overview of Sunsets

Income Tax Rates for Individuals 

Under current law, the reduced individual income tax rates created by the Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (collectively called the "Bush-Era" Tax Cuts), and extended by the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (2010 Tax Act), are scheduled to sunset after 2012. Unless extended, the individual marginal tax rates, currently at 10, 15, 25, 28, 33, and 35%, are scheduled to increase to 15, 28, 31, 36, and 39.6%, effective for tax years beginning after December 31, 2012.

Thus, unless Congress acts, all taxpayers will experience a tax hike after 2012. The top rate jumps from 35% to 39.6% and the lowest tax rate of 10% is eliminated. Even those taxpayers who remain at the 15% rate will be paying more because none of their income would be taxed at the 10% tax bracket.

Increase in Payroll Taxes 

In addition, the 2% employee-side FICA payroll tax cut, as enacted under the Middle Class Tax Relief and Job Creation Act of 2012, is scheduled to expire after 2012. This will impact all workers in 2013 on the first $113,700 of their earned income (which is the Social Security wage base for 2013).

Health Care Reform  

Health care reform will also increase many individuals' income taxes effective January 1, 2013. The Patient Protection and Affordable Care Act imposes a 0.9% Health Insurance Tax on earned income for higher income individuals and a 3.8% Medicare Contribution Tax on unearned income. Specifically, the tax will be imposed at a 3.8% rate on the lesser of (a) net investment income, such as interest income, dividends, and capital gains and (b) the excess of modified adjusted gross income over a specified dollar amount ($250,000 for joint filers or a surviving spouse, $125,000 for married filing separately and $200,000 for other taxpayers).These taxes would be imposed in addition to all other anticipated tax increases, and do not impact the regular or alternative minimum tax computation.

Capital Gains Tax 

Unless Congress acts, the 15% tax rate on net capital gains for non-corporate taxpayers will revert to 20% (10% for taxpayers in the 15% ordinary income tax bracket) after 2012.

  • Thus, the acceleration of capital gains into 2012 while the tax rates are lower is one strategy for taxpayers to consider. The "wash sale" rules that apply to claiming losses do not apply to gains. Accordingly, capital gains can be recognized and, immediately thereafter, the identical asset can be repurchased with a new tax basis established in the amount of the purchase price.
  • Under current law, the 28 and 25% capital gain tax rates for collectibles and the recaptured Internal Revenue Code section 1250 gain are scheduled to continue unchanged after 2012.
  • Only long-term capital gains realized on assets held for more than one year can benefit from the reduced net capital gains tax rate.
  • Installment payments received after 2012 are subject to the tax rates in effect as of the date of payment. Thus, the capital gains portion of payments made in 2013 and later may be taxed at the 20% rate. Therefore, electing out of the installment method should be considered.
  • After 2012, the long-term gain on the sale or exchange of property held for more than five years generally will be taxed at 18% (8% for taxpayers in the 15% ordinary income tax bracket). This rule does not apply for assets acquired by exercising an option, right or obligation to acquire the property and the taxpayer held such asset before 2001.

Income Tax on Dividends 

The maximum tax rate for qualified dividends received by an individual through December 31, 2012 is 15%. A zero rate applies to qualified dividends received by an individual in the 10 or 15% income tax brackets. Unless Congress acts, qualified dividends will be taxed at your applicable ordinary income tax rates after 2012. This means that dividend income can be taxed at a rate as high as 43.4% (i.e., top ordinary income tax rate of 39.6% plus the Medicare Contribution Tax of 3.8%).

  • Qualified corporations may consider declaring a special dividend to shareholders prior to January 1, 2013.
  • What are qualified dividends? These are dividends received from a domestic corporation or a qualified foreign corporation, on which the underlying stock is held for at least 61 days within a specified 121-day period. Certain dividends do not qualify for the reduced tax rates, such as dividends paid by credit unions, mutual insurance companies, money market funds, and farmers' cooperatives.

The following business-entity related tax breaks associated with dividends will also sunset after 2012:

  • Dividends received from regulated investment companies (RICs), real estate investment trusts (REITs), and other qualified pass-through entities are treated as qualified dividends for purposes of the reduced tax rates through 2012.
  • The accumulated earnings tax rate imposed on corporations which had been reduced to 15% through 2012 would increase to 39.6%.
  • The tax on undistributed personal holding company (PHC) income would also rise from 15% to the highest individual income tax rate.

Marriage Penalty Relief 

The Bush-Era Tax Cuts had increased the basic standard deduction for a married couple filing a joint return to twice the basic standard deduction for an unmarried individual filing a single return. The marriage penalty relief was extended through 2012. If this provision is not extended, the standard deduction for married couples will be 167% of the deduction for single individuals rather than 200%. Thus, based on 2012 numbers, the standard deduction for joint filers would drop from $11,900 to $9,950.

Further, the size of the 15% income tax bracket for a married couple filing a joint return is twice the size of the corresponding rate bracket for an unmarried individual filing a single return through 2012. After 2012, the 15% bracket for joint filers will be 167% of the upper limit for single individuals, so that the 15% bracket ends at $59,000 instead of $70,700.

  • Because the marriage relief penalty is more politically controversial than other parts of the "sunsetting provisions" and is thus very uncertain, married couples may wish to increase their withholding or make larger estimated tax payments in 2013 in order to avoid underpayment penalties.

Pease Limitation 

The "Pease" limitation on itemized deductions, which was eliminated through 2012, is scheduled to be revived starting in 2013. The Pease limitation, named after the Congressional member who sponsored the original provision, reduces the total amount of a higher-income taxpayer's otherwise allowable itemized deductions by 3% of the amount by which the taxpayer's adjusted gross income exceeds an applicable threshold. However, the amount of itemized deductions would not be reduced by more than 80%. Certain items, such as medical expenses; investment interest; and casualty, theft or wagering losses, are excluded. The applicable threshold for the Pease limitation if it was in effect in 2012 would be $173,650, (or $85,825 for married filing separately).

Personal Exemption Phase Out 

Higher income individuals may see their deduction for personal exemptions reduced or eliminated under the personal exemption phase out rules, should the phase out be reinstated starting in 2013. Under the phase out, the total amount of exemptions that may be claimed by a taxpayer is reduced by 2% for each $2,500 or portion thereof (2% for each $1,250 for married couples filing separate returns) by which the taxpayer's adjusted gross income exceeds the applicable threshold.

Alternative Minimum Tax 

There is considerable uncertainty as to what the dollar amount of the exemption from the alternative minimum tax (AMT) will be for 2012, as well as what it will be commencing in 2013. With the growing number of individuals becoming subject to the AMT, Congress has had to "patch" this exemption each year by temporarily increasing it. The exemption amounts for 2011 were $48,450 for an unmarried individual and $74,450 for married persons filing jointly and surviving spouses. If Congress fails to act, for 2012, the exemption amounts will be $33,750 and $45,000, respectively. Thus, many more individuals may find themselves subject to the higher AMT.

Tax Credits 

Child Tax Credit:  The $1,000 child tax credit is scheduled to revert after 2012 to $500 per qualifying child, who are dependents under age 17 at the end of the tax year. Further, certain enhancements such as an increased refundable component are scheduled to expire after 2012.

Adoption Credit/Adoption Assistance Programs: There will be a reduction in the maximum adoption tax credit and greater restrictions on eligibility.

Child and Dependent Care Credit: This credit, intended to assist individuals with child and dependent care expenses so that he or she can go to work or look for employment, may also be reduced after 2012. (Children must be under age 13; qualifying dependents who are disabled may be of any age if they are a dependent or spouse and living with the taxpayer for more than half a year.) Expenses qualifying for the credit must be reduced by the amount of any dependent care benefits provided by the employer which are excluded from the employee's gross wages. Total expenses qualifying for the credit are capped at $3,000 in cases of one qualifying individual or at $6,000 for two or more qualifying individuals. Unless Congress acts, the amounts will be reduced to $2,400 for one qualifying individual and $4,800 for two or more such individuals. In addition, the current 35% credit rate will decrease to 30%.

Educational Incentives 

Coverdell Education Savings Accounts: The maximum contribution amount of $2,000 is scheduled to revert to just $500 after 2012. Current law also treats elementary and secondary school expenses, in addition to post-secondary school expenses, as qualified expenses for Coverdell accounts.

Educational Assistance Exclusion: The $5,250 exclusion from income and employment taxes of employer-provided education assistance sunsets after 2012. Employers may deduct up to $5,250 annually per employee for qualified education expenses. After the sunset, employer-paid educational assistance will be excludable from gross income only if it qualifies under the more stringent working condition fringe benefit rules. These rules provide that the employee must be able to meet the business expense requirements that call for a direct relationship between the course and the employee's current job.

Student Loan Interest Deduction:  The debt must be incurred by the taxpayer solely to pay qualified higher education expenses, and the maximum deduction is $2,500. For 2012, the student loan interest deduction is reduced when modified adjusted gross income exceeds $60,000 for single filers ($125,000 for joint filers) and is completely eliminated when modified adjusted gross income is $75,000 for single filers and $155,000 for joint filers. The deductible amount cannot be reduced below zero. After 2012, the deduction would begin to phase out for single individuals whose modified adjusted gross income, estimated with inflation adjustments, exceeds $40,000 for single filers and $60,000 for joint filers, and completely phase out at $55,000 for singles and $75,000 for joint filers. The student loan interest deduction is an above-the-line adjustment to income and is available to both itemizers and non-itemizers. For tax years after 2012, interest on qualified education loans will be deductible only if paid during the first 60 months in which interest payments are required.

Higher Education Tuition Deduction:  The above-the-line deduction for higher education tuition and related expenses expired after 2011. The deduction in 2011 was a maximum of $4,000 for taxpayers whose modified adjusted gross income did not exceed $65,000 ($130,000 for joint filers) and $2,000 for taxpayers whose modified adjusted gross income exceeded $65,000 but did not exceed $80,000 ($160,000 for joint filers). Renewal for 2012 and beyond is uncertain.

American Opportunity Tax Credit: Through 2012, a credit of up to $2,500 of the cost of tuition, fees and course materials paid during the tax year is allowed. The credit is based on 100% of the first $2,000 of such expenses plus 25% of the next $2,000 of expenses. Further, 40% of the credit, up to $1,000, is refundable for lower-income taxpayers. The full credit is available for single filers with modified adjusted gross income of $80,000 or less, or $160,000 for joint filers. The credit is phased out for taxpayers with income above these levels. This credit will revert back to the Hope credit after 2012 and is based on the same education costs as the American Opportunity Tax Credit. The Hope credit will be limited to the first two years of post-secondary education; whereas the American Opportunity Tax Credit could apply to all four years of post-secondary education.

Business Owner Provisions 

Depreciation: For 2012, there is available an additional depreciation deduction of 50% of the adjusted basis of qualified property for the year in which such assets are placed-in-service. Unless Congress acts, this additional depreciation deduction will not be available after 2012. The adjusted basis of qualified property is reduced by the additional depreciation deduction before computing the amount otherwise allowable as a depreciation deduction.

  • The Code Section 179 expensing limit will plummet from $139,000 with an investment ceiling of $560,000 in 2012 to $25,000 with an investment ceiling of only $200,000 starting in 2013.
  • Certain generous luxury automobile deprecation limits are also set to expire after 2012.

Small Business Stock: Non-corporate investors may exclude a percentage of the gain realized on the sale or exchange of qualified small business stock. In order to qualify, the stock must have been issued after a certain date by a qualified C corporation and held by the taxpayer for more than five years. For stock acquired after February 17, 2009 and on or before September 27, 2010, a 75% exclusion of gain applies. And 100% exclusion of gain applies for stock acquired after September 27, 2010 and before January 1, 2012. Stock acquired before February 18, 2009 or after December 31, 2011 is subject to an exclusion of 50%. Unfortunately, the tax rate on the included amount is 28%, meaning that the exclusion gives you an effective rate of 14%, which is not that much better than the 2012 capital gains tax rate of 15%. (There may be a greater advantage in 2013 when the capital gains tax rate is scheduled to rise to 20%). In addition, 7% of the excluded gain is treated as a tax preference item subject to the alternative minimum tax (AMT). At the 100% exclusion level, none of the gain would be subject to the AMT. The reduced AMT preference rate is scheduled to increase from 7% to 42% after 2012.

  • To qualify as small business stock, it must be issued by a C corporation that invests 80% of its assets in the active conduct of a trade or business and that has assets of $50 million or less when the stock is issued.

Employer-Provided Child Care Credit: This credit, which will expire for tax years commencing after December 31, 2012, is for employer-provided child care facilities and services. The credit is the sum of 25% of the qualified child care expenses and 10% of the qualified child resource and referral expenses incurred by the employer for the tax year. The maximum amount of the credit allowable is $150,000 annually.

Federal Estate, Gift and Generation-Skipping Transfer (GST) Taxes 

Estate Tax Rates and Exclusion Amount: The Bush-Era Tax Cuts had provided that the estate tax would be repealed in 2010, and its stepped-up basis rules would be replaced with a modified carry over basis regime. The 2010 Tax Act revived the estate tax for decedents dying after 2009, but gave those estates of decedents dying in 2010 the option of either tax regime. For decedents dying in 2011 and 2012, and those 2010 estates opting for the estate tax, the maximum estate tax rate is at 35% and the exclusion amount per decedent was $5 million in 2011 and $5.12 million in 2012 ($5 million indexed for inflation). Unless Congress acts, the federal estate tax rate will increase to 55% and the exclusion amount will drop to $1 million, with no provision for inflation indexing.

Portability:  The 2010 Tax Act introduced "portability" which allows the estate of a decedent who is survived by a spouse to make a portability election to permit the surviving spouse to apply the decedent's unused exclusion (the deceased spousal unused exclusion amount (DSUE)) to the surviving spouse's own transfers during life and at death but does not increase the surviving spouse's GST exemption. Portability is available for decedents dying before January 1, 2013.

State Death Tax Credit: A credit against the federal estate tax is allowed for state estate, inheritance, legacy or succession taxes. The credit was repealed for decedents dying after 2004 and replaced with a deduction. The deduction is scheduled for repeal after 2012.

Gift Tax:  The gift tax rate is 35% through 2012. Thereafter, the rate will increase to 55%. The gift exemption was $1 million through 2010; in 2011 it was $5 million; in 2012 it is $5.12 million. Married couples have the potential ability to make lifetime gifts of as much as $10.24 million, if such gifts are made by December 31, 2012. After 2012, the gift exemption reverts to $1 million ($2 million for married couples). The gift tax is reunified with the estate tax.

  • Consideration should be given to utilizing the full lifetime exemption available before December 31, 2012. In the unlikely event that any exclusion amounts in excess of a future exclusion may be "clawed back" into an eventually taxable estate, the benefit of having any appreciation of assets gifted escape estate taxes should outweigh any potential costs.

GST Tax and Exemption:  The GST tax was repealed in 2010 and reinstated in 2011 at the 35% rate. After 2012, the rate will be 55%. The exemption was $5 million in 2011 and $5.12 million in 2012 and is scheduled to drop to $1 million beginning in 2013, plus any inflationary indexing.

Other GST Provisions: A number of other provisions will sunset beginning in 2013: the GST deemed allocation and retroactive provisions, clarification of valuation rules with respect to the determination of the inclusion ratio for GST tax purposes; and relief from late GST allocations and exemptions.

Other Estate Planning Considerations 

  • There is the risk of the potential elimination after 2012 of the long-term tax advantages of the defective grantor trust, the present federal estate and gift tax treatment of family limited partnerships and entity valuation discounts. Also, the Treasury's 2012 Green Book proposed to limit the benefits of certain estate planning techniques using grantor trust. Since 1997 there have been recurring initiatives to eliminate family limited partnership discount regimes. In 2010 there were also Congressional provisions to require a ten-year minimum term for grantor retained annuity trusts (GRATs). Any of these tax planning opportunities could be repealed by current or future estate and gift tax legislative agendas.
  • The Treasury's safe harbor interest rates utilized for estate and gift tax planning are presently at historic lows. In December 2012, the Internal Revenue Code (IRC) section 7520 interest rate is 1.2%, the annualized IRC section 7872 short-term interest rate is .24%, the IRC section 7872 mid-term interest rate is .95% and the IRC section 7872 long-term interest rate is 2.40%. The benefit of these low rates is that they make certain estate planning techniques more effective by allowing a senior family member to transfer more property to junior family members without paying any gift or estate tax. For example, assume a senior family member forms a GRAT in December 2012. A GRAT is a trust to which you can transfer property (e.g., investments that are expected to increase in value) in exchange for a fixed annual payout (with a 1.2% December 2012 interest rate) for the term of the trust. As the value of the GRAT assets increase, less trust property is needed to fund the annuity payout each year, so more property accumulates in the trust. As a result, the senior family member receives a fixed payout (at a 1.2% interest rate), and, at the end of the GRAT trust term, any remaining property (and all appreciation) goes to the junior family members gift-tax free.

TAX PLANNING GOALS 

Proper tax planning can achieve the following goals:

  • Lower this year's tax.
  • Defer this year's tax to future years.
  • Reduce your tax in future years.
  • Maximize the tax savings from allowable deductions.
  • Minimize the effect of the ATM on this year's tax liability.
  • Take advantage of available tax credits.
  • Maximize the amount of wealth that stays in your family.
  • Minimize capital gains tax.
  • Avoid penalties for underpayment of estimated taxes.
  • Free up cash for investment, business or personal needs by deferring your tax liability.
  • Manage your cash flow by projecting when tax payments will be required.
  • Minimize potential future estate taxes so you can leave the maximum amount to your beneficiaries (and/or charities) rather than the government.
  • Maximize the amount of money you will have for your retirement and education funding for your children.
 


Tax Planning Strategies

Taking all of these potential law changes into account, now more than ever, individuals and families should take steps to maximize income and gift tax savings, taking into consideration their own specific economic, financial and tax situation.

In addition, tax planning can reduce eventual estate taxes, maximize the amount of funds you will have available for retirement, reduce the cost of educating your children, and assist you in managing your cash flow to help you meet your financial objectives.

Specifically, tax planning strategies can defer some of your current year's tax to a future year, thereby freeing up cash for investment, business or personal use. This can be accomplished by timing when you pay certain expenses, or controlling when your income is recognized. Tax planning can also help you take advantage of tax rate differentials between years. However, if tax rates rise in a subsequent year, extra caution may be necessary. Tax planning can also help you prevent, or minimize, the impact of the alternative minimum tax ("AMT") by preserving the tax benefit of many of your deductions.

The key things you need to understand as you look for ways to minimize your taxes:

  • Residents of states with high income and property taxes, such as New York, California, Connecticut, Pennsylvania and New Jersey, are most likely to be subject to the AMT.
  • Long-term capital gains generally are subject to a maximum tax rate of 15% (with rates as low as 0% for lower income taxpayers). However, short-term capital gains can be taxed as high as 35%. Pursuant to the 2010 Tax Act, these rates will remain in effect through December 31, 2012. Therefore, if you have large unrealized long-term gains, it may make sense to recognize the gains in 2012 when the lower 15% capital gains tax applies. If you wait until 2013 to recognize the gains, you may subject the gains to a 20% capital gains tax rate, in addition to the 3.8% Medicare Contribution Tax on unearned income.
    • What happens if you currently have a capital loss carry-forward? In that case, it may make sense to postpone taking the long-term capital gain until 2013, so that you can apply the loss against capital gains that would be taxed at the potential higher 20% rate.
    • Under current law, the complex netting rules have the potential effect of making your long-term gains subject to short-term rates, so you must carefully time your security trades to ensure that you receive the full benefit of the lowest capital gains tax rate.
     

Year-End Tax Planning Tips

Tax Tip 1 gives you a snapshot of key strategies that will help you achieve your goals. It includes planning ideas to help you reduce your current year's tax as well as ideas to reduce your future taxes. While this chart is not all inclusive, it is a good starting point to help you identify planning ideas that might apply to your situation. Keep in mind that many of the strategies involve knowing what your approximate income and tax rates will be in 2012 and 2013, and then applying the applicable tax law for each year to determine the best path to follow. Of course, the uncertainty of the 2013 tax law adds complexity to the planning. However, implementation of many of these ideas requires a thorough knowledge of tax laws, thoughtful planning and timely action.

Tax Tip 1 — Key Tax Planning Strategies 
Situation  Planning Idea 
Your regular tax rate will be the same or lower next year and the AMT will not apply in either year. • Prepay deductions.
• Defer income.
Your regular tax rate will increase next year and the AMT will not apply in either year. • Defer deductions.
• Accelerate income, but only if the tax rate increase warrants accelerating tax payments.
The regular tax rate applies this year and is higher than the AMT rate that you expect will apply next year. • Prepay deductions, especially if they are not deductible against the AMT and would therefore be lost next year. These deductions include state and local income taxes, real estate taxes, and miscellaneous itemized deductions such as investment fees.
• Defer income.
This year you are in the AMT and next year you will be subject to a higher regular tax rate. • Defer deductions, especially those not allowed against the AMT that would be lost this year.
• Accelerate income.
You have net realized capital losses this year or loss carryforwards from last year. • Consider recognizing capital gains by selling appreciated securities to offset realized losses and loss carryforwards.  
You have net realized capital gains this year. • Sell securities with unrealized losses to offset the gains — if market conditions justify it.
• Use a bond swap to realize losses.
• Consider tax implicaations of netting rules.
• Avoid wash sale rules.
You are contemplating purchasing new business equipment. • Accelerate the purchases into 2012 to take advantage of bonus depreciation and section 179 deductions available this year. (Purchases must be placed in service in 2012.)
Your miscellaneous deductions will be reduced due to the limitation based on 2% of your adjusted gross income. • Bunch these deductions into a single year, thereby increasing the deductible amount.
Make sure you avoid the AMT. 
A penalty for underpayment of estimated taxes will apply. • Withhold additional amounts of tax from your wages
before December 31.
• Prepay fourth quarter estimates due January 15 and increase the payment amount, if necessary.
You want to diversify a concentrated low-basis stock position and avoid paying taxes currently. • Consider using a charitable remainder trust that will allow you to sell the stock in exchange for an annuity. This will allow you to defer the tax while benefiting a charity of your choice.
You have incentive stock options that you can exercise. • Consider exercising your options to start the long-term holding period, but only if the spread between the market price of the stock and the exercise price will not put you into the AMT.
Your passive activity losses exceed your passive income.
 
• Dispose of an activity that is generating passive losses in order to deduct the suspended loss on that activity.
 
You would like to make significant charitable contributions. • Donate appreciated securities you have held for more than one year.
• Consider establishing a charitable trust or a private foundation, or take advantage of a donor-advised fund.
You need funds for personal use, such as improvements to your home in excess of the mortgage limitations, or to pay tax liabilities. • Sell marketable securities with little or no appreciation to fund your needs, and then use margin debt to purchase replacement securities. The interest on the debt will be deductible, subject to investment interest limitations.
• Take distributions, if available, from partnerships, limited liability companies, or S corporations on income that you have already paid taxes on. Just make sure you have sufficient tax basis and are at risk in the entity.
You want to take advantage of the
tax-deferred nature of retirement accounts.
 
• Maximize your contributions to your retirement accounts and take advantage of the best plans available to you prior to December 31, 2012.
You expect the value of your IRA to appreciate over time, and you want to position your IRA now so that there will be little or no tax impact when you or your beneficiaries take distributions later. • Consider converting your traditional IRA into a Roth IRA in 2012. However, this will cause a current tax liability.

 
You have a sizeable estate and want to protect your assets from estate tax.
You want to transfer assets to your designated beneficiaries during your lifetime.
• Make gifts of $13,000 to each individual in 2012. For 2013, the annual exclusion increases to $14,000.
• Pay beneficiaries' tuition and medical expenses directly.
• Use your lifetime gift tax exemption of $5.12 million (effective for 2012 only).
• Create a grantor retained annuity trust ("GRAT").
• Set up a family limited partnership ("FLP") or family limited liability company ("FLLC").
• Make loans to your beneficiaries at minimum required interest rates.
 
You want to provide for your children's and/or grandchildren's college costs. • Establish a 529 plan that can grow tax-free as long as you use the funds to pay qualified education expenses.
 


Timing when you pay deductible expenses and when you receive income (to the extent you have control) can permanently reduce your taxes — especially if you are subject to the AMT in one year but not another. Timing expenses and income can also defer some of your tax to next year (or even later years) giving you, rather than the government, use of your money. However, because of the uncertainty of the 2013 tax law, it may be strategic to accelerate income into 2012 and defer deductions until 2013.

To gain the maximum benefit, you need to project, as best you can, your tax situation for both 2012 and 2013 so that you can identify your tax bracket for each year and determine whether the AMT will likely affect you in either or both years. Included in your projections should be your year-to-date realized capital gains and losses. Be sure to consider prior year loss carry forwards (if any). Based on these results, you can decide what steps to take before year-end. Should you prepay deductions and defer income, or defer expenses and accelerate income, realize capital losses, or lock in capital gains?

 

Tax Tip 2 offers basic guidance for deciding when to prepay or defer deductible expenses and when to defer or collect income. Tax Tip 3 offers steps to follow when deciding whether to take capital gains and losses, and the type of gains and losses you should trigger.

Steps to Take if the AMT Applies Either This Year or Next

As a general rule, if your 2012 year-end projection indicates that you will be in the AMT, or are highly likely to be in the AMT, it is very important that you do not pay any of the following expenses before the end of the year, since they are not deductible in computing your AMT and you will receive no tax benefit from the deduction:

  • State and local income taxes
  • Real estate taxes
  • Miscellaneous itemized deductions such as investment expenses and employee business expenses

Conversely, if it looks like you will not be in the AMT in 2012, you should try to prepay as many of the above expenses as possible to receive the maximum tax benefit. Keep in mind, though, that the more you prepay, the more likely that you will end up in the AMT.

Expenses You Can Prepay

Here are the most common deductible expenses you can easily prepay by December 31, 2012, if appropriate:  

Charitable Contributions
You can deduct cash charitable gifts to public charities totaling up to 50% of your adjusted gross income ("AGI") and charitable gifts of appreciated capital property up to 30% of your AGI (30% and 20%, respectively, if given to a private non-operating foundation).

State and Local Income Taxes
If you are not in the AMT this year, you can prepay before December 31, 2012 your fourth quarter 2012 state estimated tax payment due on January 15, 2013, and even any state income tax you project will be due on April 15, 2013. You will gain the benefit of deferring part of your federal income tax liability and protect those deductions that could be lost if you fall into the AMT in 2013. Prepaying these taxes will probably outweigh any lost earnings on the use of the funds. However, be careful that the prepayment itself doesn't put you into the AMT.

Real Estate Taxes
Like state and local income taxes, prepaying 2013 taxes early can be an especially beneficial strategy should you end up subject to the AMT next year, but would not be if you are in the AMT in 2012.

Miscellaneous Itemized Deductions
Miscellaneous itemized deductions are deductible for regular income tax purposes only if they exceed, in the aggregate, 2% of your AGI and you are not subject to the AMT. Bunching these deductions to gain the most favorable tax result may be a viable strategy.

Mortgage Interest
By prepaying your January 2013 mortgage payment in 2012, you can take the accrued mortgage interest portion as a deduction in 2012.

Margin Interest
Be sure to pay any margin interest before December 31, 2012 since interest accrued at year-end is only deductible if actually paid.

Business Equipment
You can accelerate purchases of business equipment before the end of the year to take advantage of expanded expensing allowances, subject to certain limitations. To qualify, the property must be placed-in-service in 2012. After 2012, the expanded depreciation allowances will be severely curtailed.

Income You Can Accelerate or Defer

Timing income can be more difficult than timing deductions, but here are some types of income that you may be able to control the timing of receipt so that you can gain the advantage of having the income taxed in a year that you are in a lower tax bracket.

Cash Salaries or Bonuses
If you anticipate that your 2012 income tax rate will be lower than the scheduled 2013 rate, you can accelerate salary or bonuses into 2012. You would need to determine if there are strict limitations on amounts that can be accelerated. However, if the scheduled 2013 rate is lower than your 2012 rate, it may make sense to defer such income until 2013.

Consulting or Other Self-Employment Income
If you are a cash-basis business, you can accelerate income into 2012, if your 2012 tax rate is anticipated to be lower than the scheduled 2013 rate. Otherwise, you would want to defer such income. However, you will also have to consider the impact of the change in the payroll taxes that would be imposed on such income, as there is a scheduled increase in social security taxes for 2013.

Retirement Plan Distributions:If you are over age 59½ and your tax rate is unusually low this year, you can consider taking taxable distributions from your retirement plan even if they are not required, or consider Roth IRA conversions.

Capital Gains:The following ideas can lower your taxes this year:

  • If you have unrealized net short-term capital gains, you can sell the positions and realize the gains in 2012 if you expect your 2013 tax rate to be higher. For example, this may be a good strategy if the gain will be taxed at the AMT rate of 28% this year but at the scheduled rate of 43.4% next year (inclusive of the additional Medicare Contribution Tax). But you would only consider this strategy if you do not otherwise intend to hold the position for more than 12 months, making it eligible for the long-term capital gain rate of 15% in 2012 (or the scheduled rate of 23.8% in 2013 inclusive of the additional Medicare Contribution Tax). However, you may be able to apply the netting rule which may result in the offsetting of long-term losses to short-term gains, resulting in a tax savings of 35% rather than 15%.
  • Review your portfolio to determine if you have any securities that you may be able to claim as worthless, thereby giving you a capital loss before the end of the year. A similar rule applies to bad debts. However, in view of the scheduled 2013 rate increases, you may desire to defer such action until 2013.
  • Consider a bond swap to realize losses in your bond portfolio. This swap allows you to purchase similar bonds and avoid the wash sale rule while maintaining your overall bond positions.
  • Similarly, you may consider selling securities this year to realize long-term capital gains that can be taxed at the more favorable 15% rate, and then buying them back to effectively gain a step-up in basis. Because the sales are at a gain, the wash sale rules do not apply.

Real Estate and Other Non-Publicly Traded Property Sales:
If you are selling real estate or other non-publicly traded property at a gain, you would normally structure the terms of the arrangement so that most of the payments would be due next year and you can use the installment sale method to report the income. This would allow you to recognize only a portion of the taxable gain in the current year to the extent of the payments you received, thereby allowing you to defer much of that tax to future years. However, because the long-term capital gain rate is scheduled to increase in 2013, you may instead accelerate the recognition of the entire long-term capital gain into 2012, by electing out of the installment sale treatment. Since the election does not have to be made until your 2012 tax return is filed (including extensions) in 2013, you do have time to make this decision.

U.S. Treasury Bill Income
If you have U.S. Treasury Bills maturing early in 2013, you may want to sell these bills to recognize income in 2012 if you expect to be in a lower tax bracket this year than next year.

Tax Tip 2 — Year-End Tax Tips 
  You will not be in the AMT this year or next year and your 2013 tax rate  You are in the AMT* 
Nature of deduction or income will be the same as 2012 or will decrease will increase only this year this year and next year only next year
Charitable contributions, mortgage interest, investment interest and self-employed expenses Prepay Defer Defer Prepay Prepay
State and local income taxes, real estate taxes, and miscellaneous deductions that are not deductible if you are in the AMT Prepay Defer Defer Defer Prepay
Income such as bonuses, self-employed consulting fees, retirement plan distributions, and net short-term capital gains (unless you have long-term losses offsetting the gains) Defer Collect Collect Defer Defer
Miscellaneous itemized deductions bunched (not deductible for the AMT) into a single year will exceed the 2% adjusted gross income floor Prepay Defer Defer Defer Prepay
(Legend = Prepay before Dec. 31, 2012 / Defer into 2013 or later / Collect before Dec. 31, 2012 )
*The chart assumes your regular tax rate on ordinary income is higher than the maximum AMT tax rate of 28%. 


Bunching Deductions

Bunching miscellaneous itemized deductions from two different years into a single year may allow you to exceed the 2% of AGI limitation that applies to these deductions. If you have already exceeded the 2% floor, or will do so by prepaying some of next year's expenses now, prepay the following expenses by December 31, 2012 (assuming you will not be in the AMT this year):

Investment Expenses
These include investment advisory fees, custody fees, and investment publications.

Professional Fees
The most common of these fees are income and gift/estate tax planning and tax return preparation, accounting, and legal fees (to the extent deductible).

Unreimbursed Employee Business Expenses
These include business travel, meals, entertainment, vehicle expenses and publications, all exclusive of personal use. You must reduce expenses for business entertainment and meals (including those while away from home overnight on business) by 50% before the 2% floor applies.

Medical Expenses
These expenses are only deductible if they exceed 7.5% of your AGI (scheduled to increase to 10% after 2012). For AMT purposes, the threshold is 10%. Therefore, bunching unreimbursed medical expenses into a single year could result in a tax benefit. Medical expenses include health insurance and dental care. If you are paying a private nurse or a nursing home for a parent or other relative, you can take these expenses on your tax return even if you do not claim the parent or relative as your dependent, assuming you meet certain eligibility requirements.

Adjust Year-End Withholding or Make Estimated Tax Payments

If you expect to be subject to an underpayment penalty for failure to pay your 2012 tax liability on a timely basis, consider increasing your withholding and/or make an estimated tax payment between now and the end of the year in order to eliminate or minimize the amount of the penalty.

Tax Tip 3 — Year-End Capital Gains and Losses  
If you have   Consider taking these steps 
Both short-term and long-term losses Sell securities to recognize unrealized gains, preferably if held short-term, up to the amount of your losses less $3,000.
Long-term gains in excess of short-term losses Take losses equal to the net gain, plus $3,000. Use long-term loss positions first, then short-term loss positions. But consider holding the short-term losses until next year if you anticipate net short-term gains in 2013.
Both short-term and long-term gains, or short-term gains in excess of long-term losses Take losses equal to the net gain, plus $3,000. Use long-term loss positions first to gain the benefit of offsetting short-term gains (taxed at a rate as high as 35%). If the long-term loss positions are held until next year and then sold, you may receive only a 20% tax benefit if they offset long-term gains (in 2013).
Worthless securities and bad debts Identify these securities and debts and take the necessary steps to ensure that the losses are deductible in the current year, by having the proper substantiation.
Note: If you are married, filing separately, substitute $1,500 for $3,000 in the above tip. 


Utilize Business Losses or Take Tax-Free Distributions

It may be possible to deduct losses that would otherwise be limited by your tax basis or the "at risk" rules. Or, you may be able to take tax-free distributions from a partnership, limited liability company or S corporation if you have tax basis in the entity and have already been taxed on the income. If there is a basis limitation, consider contributing capital to the entity or making a loan under certain conditions.

Passive Losses

If you have passive losses from a business that you do not materially participate in that are in excess of your income from these types of activities, consider disposing of the activity. The tax savings can be significant since all losses become deductible when you dispose of the activity. Even if there is a gain on the disposition, you can get the benefit of having the long-term capital gain taxed at 15% with all the previously suspended losses offsetting ordinary income at a potential tax benefit of 35%. It may be beneficial to consider this transaction in 2012 to gain the benefit of the lower long-term capital gains rate.

Incentive Stock Options

Review your incentive stock option plans ("ISOs") prior to year-end. A poorly timed exercise of ISOs can be very costly since the spread between the fair market value of the stock and your exercise price is a tax preference item for AMT purposes. Other issues include avoiding a cash flow problem on the exercise of options and funding taxes as a result of an exercise. You may wish to consider accelerating the recognition of such income into 2012 if such rates are lower than the 2013 scheduled rates. This strategy can also apply to nonqualified options.

Estate Planning

If you have not already done so, make your annual exclusion gifts to your beneficiaries before the end of the year. For 2012, you are allowed to make tax-free gifts up to $13,000 per year, per individual ($26,000 if you are married and use a gift-splitting election, or each spouse gives $13,000 from his or her separate funds). For 2013, the annual exclusion is increased to $14,000 per individual ($28,000 if you are married and elect gift-splitting). By making these gifts, you can transfer substantial amounts out of your estate without using any of your lifetime exemption. Also, try to make these gifts early in the year to transfer that year's appreciation out of your estate. Further, because of the increased life-time gift exemption available until December 31, 2012, you may wish to make additional gifts to fully utilize such exemption of $5.12 million ($10.24 million for married couples) before 2013. When combined with other estate and gift planning techniques, such as a GRAT, you could have the opportunity to transfer a great deal of wealth to other family members who may need financial assistance.

Tax Strategies for Business Owners

Timing of Income and Deductions

If you are a cash-basis business and expect that your 2012 tax rate will be higher than your 2013 rate, you can delay billing until January 2013 for services already performed, thereby deferring your tax until next year. Alternatively, if you expect to be in a higher tax bracket next year, or the AMT applies this year, you can accelerate billing and collections into the current year to take advantage of the lower tax rates.

Similarly, you can either prepay or defer paying business expenses so that the deduction comes in the year that you expect to be subject to the higher tax rate. This can be particularly significant if you are considering purchasing (and placing in service) business equipment. If you are concerned about your cash flow and want to accelerate your deductions, you can charge them on your credit card. This will allow you to take the deduction in the current year, when the charge is made, even though you may actually pay the outstanding credit card bill after December 31, 2012.

Business Equipment 

Significant tax benefits are available for immediate expensing of business equipment purchases in 2012. The 50% bonus depreciation is effective for qualified property placed in service in 2012. After 2012, regular depreciation guidelines apply.

Section 179 expensing rules allow you to fully deduct up to $139,000 of qualifying property placed in service in 2012. However, this rule only applies if the total amount of qualifying property placed in service in 2012 does not exceed $560,000. After 2012, Section 179 expensing will be reduced to $25,000 and $200,000 respectively.

Business Interest  

If you have debt traced to your business expenditures — including debt used to finance the capital requirements of a partnership, S corporation or LLC involved in a trade or business in which you materially participate — you can deduct the interest "above-the-line" as business interest rather than as an itemized deduction. The interest is a direct reduction of the income from the business. This lets you deduct all of your business interest, even if you are a resident of a state that limits or disallows all of your itemized deductions.

Business interest also includes finance charges on items that you purchase for your business (as an owner) using your credit card. These purchases are treated as additional loans to the business, subject to tracing rules that allow you to deduct the portion of the finance charges that relate to the business items purchased. Credit card purchases made before year-end and paid for in 2013 are allowable deductions in 2012 for cash basis businesses.

Conclusion 

Now more than ever, effective tax planning is crucial if one is to achieve certain financial goals. It is also particularly difficult this year, given the level of uncertainty in our tax laws. Nevertheless, there are opportunities available that can be achieved if one acts before the end of 2012.

This publication highlights tax planning ideas that may help you minimize your tax liability, and does not constitute accounting, tax, or legal advice nor is it intended to convey a thorough treatment of the subject matter. The best way to use this publication is to identify those issues which could impact you, your family, or your business and then discuss them with your tax advisor.

The discussion in this publication is based on current law though November 20, 2012. Future legislation, administrative interpretations and judicial decisions may change the advisability of any course of action. You should always check with your tax advisor before implementing any tax planning idea.

Any information contained in this publication is not intended or written to be used, and cannot be used, for the purpose of (a) avoiding or reducing penalties that may be imposed by the Internal Revenue Service or any other government authority, or (b) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

Editorial team: 

Marie Arrigo, Editor-in-Chief
Jerry Cohen
Richard Lichtig
Brent Lipschultz
Tom Hall

Browse Articles By Topic: Tax Services
EisnerAmper is an independent member of PKF North America.
PKF North America is an independent member of PKF International.