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Individual Tax Planning

By December 13, 2012No Comments

Year-end planning for 2012 requires a combination of multi-layered strategies, taking into account a variety of possible scenarios and outcomes. Every tax situation is different and requires a careful and comprehensive plan. We can assist you in aligning traditional year-end techniques with strategies for dealing with the uncertainties created by Congress’s delay in addressing sun setting tax rates and the extension of other major tax benefits. Particularly as applied to the 2012 year-end circumstances, the following planning techniques should be considered:

Income Acceleration:
• Receive bonuses before January 2013
• Sell appreciated assets and postpone the sale of depreciated assets
• Redeem U.S. Savings Bonds
• Complete Roth conversions
• Maximize retirement distributions
• Accelerate billing and collections
• Equity compensation and option exercise
• Installment sale – possible elect out of installment treatment

Deductions/Credit Deferral:
• Bunch itemized deductions into 2013/Standard deduction into 2012
o Proposals exist for a variety of limitations on itemized deductions, including overall
deduction limits and mortgage interest limitations for 2013 and future years.
• Postpone bill payments until 2013
• Consider timing of property taxes on rentals and residences
• Pay last state estimated tax installment in 2013

Other Planning Ideas:
• Maximize contributions to employer-sponsored retirement plans. The 401(k) limit is $17,000 in
2012. An additional $5,500 can be contributed if you are 50 or older.
• Maximize self-employed retirement plan contributions with a SEP; you can contribute up to
25% of your net self-employment income up to a maximum of $50,000 for 2012.
• Defined Benefit Plan contributions can be up to $200,000 for 2012.
• Accelerate medical expenses. The threshold for deducting these expenses, now 7.5% of
adjusted gross income, rises to 10% in 2013 for most taxpayers.
• Take Required Minimum Distributions from IRAs.
• Contribute to a flexible spending account for 2013
• Consider making charitable contributions.
o Donate long-term, low-basis (appreciated) stock.
o Contribute to donor advised fund
• Accelerate payment of qualified education expenses

Major Changes:
Year-end tax planning is complicated by the uncertainty of tax legislation. A combination of events including the expiration of some or all of the “Bush era” tax cuts, the imposition of Medicare taxes on investment income and wages, and doubts about the renewal of tax extenders has many taxpayers asking how they can prepare for 2012 and beyond. In order to prepare for these events, we have outlined the major tax changes that are currently scheduled to take place.

Ordinary Income Tax Rates: Beginning in 2013, the current 10%, 15%, 25%, 28%, 33% and 35% individual tax rate structure will be replaced by the higher pre-2003 rates of 15%, 28%, 31%, 36% and 39.6% rates. (Congress could still make a change here.)

Long Term Capital Gains: Beginning in 2013, the current favorable rates of 0% for taxpayers in the 10% and 15% brackets and 15% for all other taxpayers will be replaced by pre-2003 rates of 10% for taxpayers in the 15% bracket and a maximum 20% rate for all other taxpayers. (Congress could still make a change here.)

Qualified Dividends: The current rates of 0% for taxpayers in the 10% and 15% brackets and 15% for all other taxpayer is scheduled to be replaced by taxation under the applicable ordinary income tax rates. (Congress could still make a change here.)

3.8% Medicare Contribution Tax: Taking effect immediately on January 1, 2013, the Medicare surtax will be imposed on a taxpayer’s “net investment income” (NII). However, the Medicare surtax will not apply to income derived from an active trade or business, or from the sale of property used in an active trade or business. For individuals, the Medicare surtax is based on the lesser of the taxpayer’s NII or the amount of “modified” adjusted gross income (MAGI) (AGI with foreign income added back) above a specified threshold.

The MAGI thresholds are:
• $250,000 for married taxpayers filing jointly or a surviving spouse;
• $125,000 for married taxpayers filing separately; and
• $200,000 for single and head of household taxpayers.

NII includes:
• Gross income from interest, dividends, annuities, royalties, and rents, provided this income is
not derived in the ordinary course of an active trade or business;
• Gross income from a trade or business that is a passive activity;
• Gross income from a trade or business of trading in financial instruments or commodities; and
• Net gain from the disposition of property, other than property held in an active trade or

Additional 0.9% Medicare Tax: Also effective January 1, 2103, higher income individuals will be subject to an additional 0.9% Medicare tax. The additional Medicare tax means that the portion of wages received in connection with employment in excess of $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately) will be subject to a 2.35% Medicare tax rate, as opposed to the current 1.45%. The additional Medicare tax is also applicable for self-employed individuals.

End of 2% Payroll Tax Reduction: Under current law, that 2% reduction in payroll taxes is scheduled to expire. On January 1, 2013, the employee’s share of payroll taxes will revert from 4.2% to 6.2%. (Congress could still make a change here.)

Alternative Minimum Tax: The alternative minimum tax (AMT) rates (26 and 28 percent on the excess of alternative minimum taxable income over the applicable exemption amount) are not scheduled to change in 2013. As in past years, taxpayers are waiting to see if Congress will enact an AMT exemption patch for 2012. The taxpayer should consider their exposure assuming the patch is not enacted and assuming the patch is enacted.

Personal Exemption Phase-Out: The personal exemption phase-out was repealed for 2012, but is scheduled to return in 2013 unless the repeal is extended. Revival of the personal exemption phase-out rules would reduce or eliminate the deduction for personal exemptions for higher income taxpayers starting at $267,200 AGI for joint filers and $178,150 for single filers. (Congress could still make a change here.)

Itemized Deduction Phase-Out: The return of the limitation on itemized deductions would reduce itemized deductions by the lesser of: (Congress could still make a change here.)
• 3% of the amount of the taxpayer’s AGI in excess of a threshold inflation-adjusted amount
projected for 2013 to be $178,150 ($89,075) for a married individual filing separately), or
• 80% of the itemized deductions otherwise allowable for the tax year.

Self-Employed Business Expenses: Some frequently overlooked business expenses that you may be able to deduct include moving expenses, costs of travel away from home, entertainment expenses, and expenses related to a home office. In addition, there are multiple benefits when you employ your spouse, child, or other family member in the business.

Section 179 Depreciation Expense: The expense allowance on the purchase of new and old equipment can provide a significant deduction. The 2012 deduction limitation is $139,000 and is scheduled to decrease to $25,000 thereafter. These deductions are phased-out if property is purchased in excess of $560,000 in 2012 and $200,000 in 2013. (Congress could still make a change here.)

Bonus Depreciation Bonus depreciation for 2012 is 50% for new asset purchases and is set to expire on January 1, 2013. (Congress could still make a change here.)

1099 Requirements: If you are an employer, you must withhold income and employment taxes from an employee’s income. However, if your workers are independent contractors, you are only required to report payments of $600 or more on a Form 1099-MISC, Miscellaneous Income. This excludes payments to corporations and government entities. Failing to file these forms could result in additional taxes, interest and penalties.

California Proposition 30: The proposition raises California’s sales tax rate to from 7.25% to 7.5%. In addition, it retroactively raises the personal income tax rates as of January 1, 2012 to the following:

Additional Tax Rate Total Marginal Tax Rate Married Filing Jointly Single
1% 10.3% $500,001-$600,000 $250,001-$300,000
2% 11.3% $600,001-$1,000,000 $300,001-$500,000
3% 12.3% Over $1,000,000 Over $500,000

Mental Health Tax: Proposition 30 does not change the additional 1% owed on income over $1,000,000. This brings the top California marginal tax rate to 13.3%.

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