Year-End Tax Plans Focus On 2012 Rule Changes

FROM /www.fa-mag.com-

Year-end tax planning for U.S. taxpayers may be more about what's happening next year.
While there aren't major changes to federal tax law for 2011, there's an "overhang of uncertainty" about what Congress will do next year to reduce the national debt and improve the economy, said Clint Stretch, managing principal of tax policy at Deloitte Tax LLP in Washington.
"There are a lot of unhappy people and a lot of unhappy businesses out there because they want to know what the rules are," said Stretch.
Decisions by lawmakers in 2012 may affect everything from federal levies on income to estate-tax laws. One rule change investors can plan for next year is a new tax-reporting requirement for mutual funds and most ETFs.
Starting next year, financial-services firms will have to report to the Internal Revenue Service and customers information on the cost basis, which is usually the purchase price, of mutual funds and most ETFs bought and sold after Jan. 1, 2012. That means investors will have to decide before selling what reporting method they want to use such as average cost or first shares acquired. Firms already are required to report the cost basis of individual stocks bought after Jan. 1 of this year to the IRS.
"Gone are the days when you can take all your statements in the tax season and go to your accountant and say, 'OK, use all these forms and use them to determine the basis,'" said Maria Bruno, a senior analyst in the investment counseling and research group at Vanguard Group Inc. "Now you really have to think about it at the time of the transaction."
An estimated 44 percent of U.S. households, or about 52 million, owned mutual funds in 2011, and 3.5 million households held ETFs, according to an October research report by the Investment Company Institute, a Washington-based trade group for the mutual-fund industry. Shares of exchange-traded funds, known as ETFs, trade on stock exchanges and don't have a fixed number of shares outstanding.
The IRS has been phasing in the cost-basis reporting rules for financial firms by investment type. The requirements began this year for equities bought and sold after Jan. 1. As a result, taxpayers will use a new Form 8949 for their 2011 returns to record capital gain and loss transactions, said Eric Smith, an IRS spokesman. The form lets investors provide information about securities covered by the law and those acquired prior to the rules, or non-covered shares, according to the IRS.
Next year the legislation extends to mutual funds, most ETFs and dividend reinvestment plans, which generally require investors to reinvest at least 10 percent of dividends paid. In 2013, it includes options (VIX) and fixed-income securities, such as bonds, according to the IRS. The changes don't apply to assets in tax-deferred retirement accounts including 401(k)s and IRAs, the IRS said.
The changes are designed to improve tax compliance and reduce the record-keeping burden for investors by ensuring that they receive the information they need to easily report their gains and losses correctly, said Smith.
Investors may set a preferred method for their firm to use when determining cost basis and investment providers generally will use a default, said Bruno of Vanguard, the world's largest mutual-fund company. While customers can change their decisions at the time of sale for a specific transaction, "there are no do-overs" after securities are sold, she said. Vanguard, based in Valley Forge, Pennsylvania, is encouraging customers to designate a preference before year-end. It can be done online or by mailing a form, Bruno said.
"If you're doing some tax planning and trying to match gains and losses, you may end up using different cost basis methods for different sales," said Lisa Featherngill, managing director of wealth planning for Wells Fargo (WFC) Family Wealth.
For example, taxpayers may have bought shares of stock at $23 this year, so they're covered under the new rules, and additional shares of the same company at $20, said Featherngill, who's based in Winston-Salem, North Carolina, and a certified public accountant. If the security's current value is $18, the investor may tell the brokerage firm to sell the shares with the highest purchase price to generate the biggest loss, she said.
When capital losses exceed gains, the extra can be deducted on individuals' tax returns and used to reduce other income, such as wages, up to an annual limit of $3,000, according to the IRS. If the total loss is more than the cap, the unused portion may be carried over to following years.
Some investors have dwindled away large capital losses that built up and were carried over in 2008 and 2009, which is why they should review whether to take some this year, said Bill Fleming, managing director in the private company services group at accounting and advisory firm PricewaterhouseCoopers LLP.
Many mutual funds distribute taxable capital gains at year- end, which individuals also should consider in their planning, said Clay Stevens, director of strategic planning at Aspiriant, a Los Angeles-based wealth management firm serving clients with at least $5 million in investable assets.
Investors who bought shares of a fund in the middle of the year may have lost money, especially as equity markets have been volatile, while a fund may have had a gain for the year overall, said Stevens. "It may be appropriate to sell a fund to avoid realizing the gain," he said.
Taxpayers who do "harvest" losses should keep in mind that the IRS prevents them from reinvesting in the same or substantially identical investment for 30 days before and after the sale, said Timothy Steffen, director of financial planning for Robert W. Baird & Co. in Milwaukee. And individuals shouldn't upset their long-term investment plan "just to get a tax break," said Rande Spiegelman, vice president of financial planning at Charles Schwab Corp. (SCHW)'s Center for Financial Research.
There also may be tax changes at the state level that individuals should consider, said Elda Di Re, area leader of the personal financial services tax division of Ernst & Young in New York.
New York Governor Andrew Cuomo and legislative leaders reached an agreement on Dec. 6 to create new tax brackets that would cut taxes for married couples earning less than $300,000 and set a maximum levy of 8.82 percent for those joint filers earning more than $2 million. Under a so-called millionaire's tax that is scheduled to expire on Dec. 31, those making more than $500,000 are taxed at 8.97 percent.
Saul Brenner, a tax partner at accounting and advisory firm Berdon LLP, said he had told clients in New York to postpone closing deals until January because of the expected lower rates.
There are other federal tax breaks set to expire at the end of 2011 that individuals may want to use while they still can, said Ted Sarenski, a certified public accountant and president of the fee-based financial planning firm Blue Ocean Strategic Capital in Syracuse, New York. That includes a rule related to charitable donations from IRAs, Sarenski said.
Owners of traditional IRAs, which generally have tax- deferred contributions, must take annual distributions starting at age 70 1/2 or over, according to the IRS. This year, savers are allowed to donate up to $100,000 from their IRA directly to a qualified charity without paying income tax on that money.
"That's often a good way to get rid of the required minimum distribution without it hitting your income," said Stevens of Aspiriant. The tax break doesn't include gifts to so- called donor-advised funds or private foundations, and the payment must be a direct transfer from the IRA trustee to the qualified charity, according to the IRS.
Congress has in the past extended, or retroactively extended, miscellaneous tax breaks that are expiring such as deductions for teachers or the so-called patch on the alternative minimum tax, said Di Re of Ernst & Young. "They always seem to be able to pull that out of the bag at the last minute," she said.
The alternative minimum tax requires taxpayers to compare their tax liability under the regular tax code with what they would owe under the AMT, which doesn't allow taxpayers the full benefits of state and local tax deductions or personal exemptions. Because the AMT wasn't indexed for inflation, over time it captures more Americans and Congress has spared some with a series of annual "patches."
Lawmakers also are debating the extension of a payroll tax cut for workers that expires Dec. 31. Senate Democrats are heading toward a Dec. 9 vote on a plan to pay for it with a 1.9 percent surtax on annual income exceeding $1 million, which Republicans have declared unacceptable.
Advisers including Di Re of Ernst & Young and Fleming of PricewaterhouseCoopers said the biggest changes they're planning for may come at the end of next year.
A provision letting individuals generally gift up to $5 million during their lifetime without paying tax is set to expire at the end of 2012 and revert to $1 million unless Congress acts. Those wanting to move money out of their estate should consider making a plan to use some or all of that gifting opportunity as they prepare this year's return, said Di Re.
In 2013, higher earners also may see a "double whammy" from increased levies on income and investments, said Fleming.
The health-care bill passed by Congress in March 2010 included a 3.8 percent tax starting in 2013 on investment income such as realized capital gains, plus a 0.9 percentage point rise in the Medicare payroll tax on wages for those couples earning more than $250,000 and for individuals making at least $200,000.
President Barack Obama also has proposed letting tax cuts enacted during the presidency of George W. Bush expire at the end of 2012 for those same higher earners, meaning levies on their income increase to as much as 39.6 percent from 35 percent.
"We're telling people, get ready to bunch your income in 2012 and postpone deductions in 2013," Fleming said. "You can't turn income on a dime. You have to plan months and months ahead of time."

Year end business tax tips

 

1. It May be Time to Shop

For companies planning on acquiring property in 2012 or 2013, there may be enhanced savings by making the acquisitions in 2012. Under current law scheduled to expire on Dec. 31, a company can take “bonus” depreciation of 50 percent of the cost for qualified property acquired and generally placed in service by year-end 2012. A company is also allowed, under certain circumstances, to expense up to $139,000 of qualified property in 2012—an amount that drops to $25,000 next year.

2. Put a Veteran to Work

 

Hiring a military veteran is hugely beneficial to small-business owners this year. As part of the Work Opportunity Tax Credit, any money paid to a qualified veteran (check list for qualifications) can be written off, dollar-for-dollar. The Work Opportunity Credit of up to $9,600 is still available for hiring an unemployed veteran, but in order to be eligible for the credit, you must have the qualified veteran start work before 2013.

 

3.  Accelerate billing and collections.

If you report income on a cash basis method of accounting, immediately sending out bills to increase collections before the end of the year may result in significant tax savings.  Choose your best or most loyal customers out of the bunch and call them to ask for payment right away. Tax brackets will go up at least 5 percent next year, so if you can get your clients to pay you this year, you’ll pay less in taxes.            Provide clients with an incentive to pay early by offering them a small discount, say, 1 to 2 percent.

4.  Pay Your Children

Does your 10-year-old file papers at your office a few times a week? If so, your child could get you a nice tax write-off.  If your child makes $5,250 or less in a calendar year, you get to deduct the entire amount and your child doesn’t need to claim the earnings. What’s better: you can take up to $5,000 of what they earned and put it into an IRA. Most parents will pay their child $250 and put the rest into a retirement fund that the child can access when they are old enough.

5. Startup Expenses

Did you know that you may write off the expenses you incur in the investigatory or startup phase of your business? Eligible expenses include planning, consulting with professionals, training employees and all other ordinary and necessary expenses incurred to get your business off the ground. This deduction works once the business is operational, so if you are still in startup mode on Dec. 31, you must defer the deduction to 2013. The IRS defines an operating business as one that has opened its doors or is accepting transactions.

 

You can deduct $5,000 of business startup expenses. If your total exceeds that, you may amortize the remainder over 180 months. There are special rules and limitations, so discuss this area with your tax professional.

6. Set up or Fund your Retirement Plan:

Your business needs working capital, but don’t forget about funding your future. Contributions made to retirement plans reduce your taxable income. For 2012, self-employed individuals can contribute $17,000 as a 401(k) deferral, plus 25% of net income. Check with your plan administrator for limits and deadlines for different types of plans.

7. Holiday Party!

Holiday festivities provided for your employees are 100% deductible. Parties for clients and associates are 50% deductible. But there are rules. You must have a business purpose and that consists of more than just promoting goodwill or networking and the expense cannot be lavish or extravagant.

8. Expense Account Reimbursements:

Gather together all those receipts for business expenditures you paid out of personal funds and have your business reimburse you before year end. If your business is operating as a C Corporation, be sure you have an accountable expense plan in place. Post your expenses to a spreadsheet and total by category of expense. Attach all receipts to provide bona fide back up documentation and then cut yourself a check and know that you have just reduced taxable income.

Fiscal Cliff Complicates Year-end Tax Planning

The “fiscal cliff” has made year-end financial planning especially daunting this year.

Uncertainty, the saying goes, breeds uncertainty. And it’s up in the air as to whether Congress will take action to head off a significant reduction in federal government spending and the expiration of Bush-era tax cuts that are scheduled to take effect January 1. Nor is there any clarity on what alternatives Congress might decide on.

However, income tax planning must go on, even in this uncertain tax environment. As a result, it is essential to know the customary year-end planning techniques that cut income taxes

It all starts with a tax projection of whether the taxpayer will be in a higher or lower tax bracket next year. Once their tax brackets for 2012 and 2013 are known, there are two basic income tax considerations.

• Should income be accelerated or deferred?

• Should deductions and credits be accelerated or deferred.

 

Capital gains: Take advantage of historically low taxes on long-term capital gains, which apply to stocks and other investments owned for at least a year.

Regardless of what tax bracket you’re in, many expect taxes on capital gains to rise. Currently, individuals with ordinary income above $35,350, or married couples with ordinary income above $70,700, pay 15 percent in capital gains taxes. Those below that level pay no capital gains taxes. Ordinary income includes all income except for income eligible for reduced tax rates, such as dividends and long-term capital gains.

Because of the tax uncertainty, some investment advisers say it makes sense to look at selling stocks that have appreciated significantly before the end of the year to avoid a higher tax bill down the road.

Something else to consider: If you’re selling a stock and taking a gain on it, there are no negative tax implications if you turn around immediately and buy the stock again. That’s different than when you sell a stock for a loss. In that scenario, you can’t claim a loss if you buy the stock again within 30 days

Don’t run out and trigger capital losses to offset capital gains or ordinary income given that this year’s tax rates on both capital gains and ordinary income are likely to look like a bargain compared to the rates that take effect in 2013.

Charitable contributions : Because of the tax uncertainty it might make sense for families to speed up their charitable giving to the end of this year instead of next.

Roth IRA: If you’ve been contemplating converting your traditional IRA to a Roth IRA, the time may be ripe.  With traditional IRAs, you invest pre-tax dollars and pay taxes when you withdraw funds. With a Roth IRA, however, you invest after-tax dollars but pay no taxes when you withdraw funds.  Now could be a good time to convert to a Roth IRA. In future years, your tax rates are likely to be higher.  A conversion is not to be taken lightly, however, because you’ll have to pay taxes on the converted funds.

Income Acceleration:  For taxpayers who think that they will be in a higher tax bracket,  receive bonuses before January 1, 2013. If your employer allows you the choice, this may create some significant income tax savings. Also, be aware that certain high-income earners will pay an extra 0.9 percent in Social Security taxes on earned income above certain thresholds starting in 2013.

AMT - Certain deductions that can be helpful in keeping tax bills low are worthless if you are in the AMT. Among them are deductions you get for paying state income taxes, local property taxes or mortgage interest. In a year when you are going to be in the AMT, it’s best — if possible — to delay paying taxes and mortgages in December and pay them in January.

Get Medical and Dental work done:  Another health care act tax provision will make it more difficult to claim itemized medical deductions. For 2012 taxes, medical deductions must exceed 7.5 percent of adjusted gross income before they can be claimed. In 2013, the expenses must be more than 10 percent of AGI. If there is a chance of exceeding the 7.5 percent floor this year, the individual may want to accelerate into this year discretionary medical expenses, such as prescription glasses and sunglasses, and elective medical or dental procedures not covered by insurance.

Year end tax planning – It’s different this time

Traditional tax planning has often been summarized and oversimplified into one phrase: “defer income and accelerate deductions.” Well, in light of the changes scheduled to occur Jan. 1, as well as our politicians acting like lemmings ready to go over the “fiscal cliff,” that may not be the best advice.
Starting next year, and without legislative action, the 2001 and 2003 tax cuts will expire, and new
Medicare taxes enacted as part of health care reform will take effect.
The expiration will eliminate several benefits, including:
• Rate cuts across all income brackets
• The full repeal of the personal exemption and itemized deduction phase-out
• The top rate of 15 percent for capital gains and qualified dividends
• Marriage penalty relief and the $1,000 refundable child tax credit
In addition, there are Medicare tax changes and additions. First, the rate of the individual share of Medicare tax will increase from 1.45 percent to 2.35 percent on earned income above $200,000 for single, and $250,000 for joint filers. The 1.45 percent employer share will not change, creating a top rate of 3.8 percent on self-employment income. In addition, investment income such as capital gains, dividends and interest will be subject for the first time to a 3.8 percent Medicare tax to the extent income exceeds $200,000 (single) or $250,000 (joint).
Between rate increases and deduction decreases, the top combined rates on income jump to 24 percent for capital gains, 43 percent for dividends and interest, and more than 42 percent for earned income.
As we can see, it may not make the best sense to defer income into next year in light of these tax rate increases. Alternatively, it may make sense instead to defer deductions and actually accelerate income.
The easiest income to control is capital gains. You can trigger gain and pay tax on stock and other securities without changing position. There is no wash sale rule on capital gains, so stock can be sold and bought back immediately to recognize the gain. But if much of your net worth is tied up in one asset because you’re deferring the tax bill on a large gain, this might be a good time to reallocate that equity.
You may also be able to affect tax by timing how you exercise options. If you do not plan to hold incentive stock options (ISOs) long enough to qualify for capital gains treatment, you can exercise them and sell the stock before tax rates increase.
You can also consider a conversion from a 401(k) or traditional individual retirement account (IRA) to a Roth IRA now, while tax rates are low. Tax will be owed on the amount of the conversion now in exchange for no tax on future distributions if the conversion is made properly and certain other conditions are met.
You might also consider electing out of the deferral of gain available in an installment sale. Deferred income on most installment sales can be accelerated by pledging the installment note for a loan.
Caveats:
First, determine whether tax increases will apply to you. Tax increases are unlikely to affect any income below the income thresholds of $200,000 (single) or $250,000 (joint), and taxes may not increase at all.
Also, if you’re subject to the alternative minimum tax (AMT), you may not benefit from any acceleration in tax. In addition, economic considerations should always come before any tax-motivated sale. We strongly suggest discussing tax strategies within the context of your overall financial plan.
Lastly, let’s hope our political leaders prove our lemmings metaphor wrong and actually deliver some clarity to taxpayers in 2013.

2012 Year-End Tax Planning Considerations

Consider your future income, capital gain and payroll taxes:

The current tax environment is very uncertain. One thing is certain, if Congress does not take action before the end of the year, tax rates are scheduled to go up for 2013. The tax increases include the following:

• The maximum marginal tax rate on long term capital gains will increase from 15% to 20%
• Qualified dividends increase from 15% to ordinary income rates (high of 39.6%)
• Marginal tax rates increase for ordinary income and the low 10% bracket will be eliminated
• Payroll taxes increase from 4.2% to 6.2% on employees resulting in an additional 2% in tax

It is possible that Congress will act and these tax increases will be averted. However, even if Congress does act, it is likely that high net worth individuals will still experience a tax increase next year.

Consider your exposure to the 3.8% Medicare surcharge tax:

On January 1, 2013, certain provisions of The Health Care and Education Reconciliation Act of 2010 (the “Act”), including imposition of a new 3.8% Medicare surcharge tax, go into effect. The Medicare surcharge tax applies as follows:

• The net investment income for high income taxpayers includes a 3.8% Medicare surtax on the lesser of two amounts: (1) their net investment income, or (2) the excess of the taxpayer’s modified adjusted gross income over a threshold amount
• The threshold amount is $200,000 for single filers or $250,000 for joint filers and $11,650 for irrevocable trusts and estates with discretionary distribution provisions
• Investment income is defined to include taxable interest and dividends, long and short term capital gains, annuity income, passive rental income, royalties, and passive activity income

Accelerating investment income in 2012 may be advantageous for you. The 3.8% Medicare surcharge tax is imposed on passive activities but not on income derived from an active business. Together with your accountant and financial planners, you may want to assess whether to sell assets and recognize gain, accelerating income this year to avoid the imposition of the 3.8% Medicare surcharge tax next year. Individuals may want to assess whether they are active or passive and explore opportunities of becoming active in their trade or business.

Consider the future of estate and gift taxation:

For the remainder of 2012, the combined gift and estate tax exemption is at $5,120,000 per person. The exemption significantly expands one’s ability to make lifetime gifts without incurring a gift tax. Time is running short to take advantage of the certainty of current law:

• A married couple can gift a total of $10,240,000 free of any gift tax
• Many states impose an estate tax, but far fewer impose a gift tax
• Even at this late date, if you want to make lifetime gifts of amounts above $1,000,000 there is time to effectively and completely make gifts of your assets, removing them from your estate for estate tax purposes
• Each person can make annual tax-free gifts of $13,000 per person, per recipient, as well as unlimited direct gifts for educational and medical expenses

Currently, this historically large exemption is scheduled to expire on December 31, 2012, with a return to a $1,000,000 exemption and a 55% federal tax rate on gifts over that amount. There is much speculation whether Congress will adopt an exemption over $1,000,000, but the fact is that no one knows and everyone is guessing. Where your legacy is concerned, don’t be caught short relying on speculation.