What to do for 2012 Tax Planning – the Answer is Not Quite as Easy as in Prior Years!

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It has long been a rule of thumb in the tax community to try and accelerate deductions while trying to defer income. This rule has been tipped on its head because of the scheduled expiration of the Bush Tax Cuts and the impending additional Medicare tax of 3.8%. We, as your tax professionals, can only state the facts to our clients and professional partners. One fact is that until Congress addresses the Bush Tax Cuts we need to be prepared for the worst. Smart timing of income and expenses can reduce your tax liabilities for 2012 and beyond.

The reality is that most of our clients are expecting or should expect to be in a higher federal tax bracket in 2013. For starters, the top ordinary income tax bracket for federal purposes is scheduled to go from 35% to 39.6%. If taxpayers have a tremendous amount of wages, passive or investment income, or self-employment income in excess of the “threshold amount” they could expect to pay federal tax at a rate closer to 43.4% in 2013.

So what are we telling our clients? Proceed with caution. To the extent that you have the ability to accelerate a long-term capital gain, for example, consider it. Potentially, the only harm could be the time value of money on any dollars spent to pay this tax. The reality is that whether rates stay at 15% for long-term capital gains or go to the scheduled 20%, a 5% savings by triggering an early gain could be worth it.

Enough with the bad news, how about more bad news?

California’s Proposition 30, with increased income tax rates for higher income taxpayers, passed on November 6 (see our August Newsletter). As a California resident, did you ever think that you might be paying taxes at a rate of approximately 56% of your income? Truth is, if you are a high income individual with a lot of investment income you could potentially be pretty close to this rate.

So what does this mean? Other than the fact that you will have less disposal income, it means that your deductions might be more valuable next year (2013) than in 2012. The same deduction is more valuable and saves more tax, all things considered equal, when you’re subject to a higher tax rate. But all things will not be equal in 2013, the dreaded Pease limitation (adjusted gross income (AGI)-based phase-out) may limit the benefit of many deductions 2013.

Gifting Opportunity

If you have a large net worth, there is another issue to consider before the end of 2012. The Bush era tax cuts weren’t just for income taxes. They were for estate and gift taxes too. The current rates and lifetime limits are scheduled to expire at the end of 2012. Potentially, gifts up to $5,120,000 could be made in 2012 by any person with no gift tax. In 2013, that limit is reduced to $1,000,000, and gifts in excess of that amount will be taxed at 45%. Perhaps 2012 is a good year to make gifts that you have been considering.

At this point in your reading you are asking yourself “What should I do?”

Our answer is simple – contact your tax service representative at White Nelson Diehl Evans and schedule a tax planning session. There are too many variables that must be considered to properly time income and deductions.

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