Mid-Year Personal Tax Planning

By: Bill Killory, CPA (Jul, 2012)

Tax planning this year is similar to consulting with the Magic 8 Ball with results like "cannot predict now" or "reply hazy, try again later".  With this being an election year and with political rhetoric about as hot as our recent weather the likelihood of having a definitive agreement amongst the two legislative bodies and the administration before November 6 is none too great.  We do know what the rates are for 2012 and we do know what rates are scheduled to go to in 2013 if no action is taken in Washington to alter the present course.

What we do know for 2012 is that tax rates are at historical lows.  The top ordinary income rate for married individuals is 35% on incomes in excess of $388,350.  Qualified dividends and long-term capital gains are taxed at a maximum rate of 15% and personal exemptions and itemized deductions are not affected by adjusted gross income phase-outs for regular tax.  The AMT exemption this year reverts to $45,000 for married taxpayers a reduction of $27,450 from 2011.  This could mean a $7,000 surprise next April for those not currently affected by AMT.

For owners of businesses operating as a partnership, S-Corp or Schedule C the federal 50% bonus depreciation is still available for purchase of new assets with a life less than twenty years.  The fixed asset expensing election under Section 179 is reduced to $139,000 in 2012 along with a much lower limitation on total assets purchased.  The expensing election will be limited to roughly $35,000 in 2013 and the bonus depreciation will be eliminated entirely next year.

For 2013 the scheduled tax rates will start at 15% (up from 10%) and will rise to a nominal 39.6% for ordinary income.  The so-called marriage penalty will resurrect itself where rates and standard deductions go from double the single amounts to 167% of the single amount. The actual amounts will be adjusted for inflation but the top nominal rate for married taxpayers will start at $324,500 a decrease of $63,850 from where the top rate starts for 2012. 

The nominal rate can be significantly different from your marginal rate (the percentage paid on the last dollar of income) because of elimination of benefits due to exceeding adjusted gross income levels.  Credits, such as the child credit and education credits currently get limited and phased out as your AGI increases.  This will be exacerbated by the return of the exemption phase-out and the 3% add-back for itemized deductions next year.  The loss of exemptions in 2013 for joint filers starts with AGI that exceeds $261,650 with the exemption benefit fully exhausted at an AGI of $384, 150.  The 3% add-back is expected to start at AGI’s exceeding $174,450 next year.   The Affordable Care Act, recently affirmed by the Supreme Court, will add an additional 0.9% Medicare tax on wages in excess of $250,000 starting in 2013.  This would include married taxpayers whose combined W-2’s exceeded this amount even if both were below this level.  There is an additional 3.8% tax on investment income for those with AGI over $250,000 starting next year.

Long term capital gain rates are scheduled to be 20% next year and qualified dividends will be taxed as ordinary income starting next year and both are subject to the additional tax on those with AGI’s above $250,000.  The dependent child credit is scheduled to be reduced from $1,000 to $500 and will not reduce Alternative Minimum Tax next year.  The child care credit is also scheduled to be reduced to $2,400 per child for up to two qualifying children from the current $3,000 per child maximum.  There are scheduled reductions in education related credits and an elimination of the deductions for tuition and fees slotted for next year as well.

Business owners should look at fixed asset purchases scheduled for this year and the upcoming years to take advantage of the more generous deduction for this year.  The key to using the bonus depreciation deduction is that the asset must be placed in service this year.  Owners of closely held C-Corporations or owners of an S-Corp with prior C-Corp earnings and profits may want to consider paying out a dividend this year.  Those of you with significant portfolios with potential capital gains may want to consider taking those gains this year.  If you are sitting on potential losses you may want to defer those to future years to offset gains at a higher rate.

Using the Magic 8 Ball is not our recommended tax planning practice.  It is likely that some tax law will be enacted before year-end.  Relatively modest taxpayers will be significantly affected by the changes that are currently in place for 2012.  The AMT exemption, the elimination or reduction in various tax credits along with an increase in tax rates could mean a doubling of federal taxes for these taxpayers in 2013 compared to 2011.  High income taxpayers get little benefit from most tax credits but will face steep increases in the amount they pay next year due to increased rates, lost exemptions and deductions and increased taxation of investment income. 

We will keep our eye on pending legislation and in the meantime you should be putting pencil to paper to see what tax planning moves you should prepare for.  As always, please contact your Dermody, Burke & Brown tax professional if you have any questions.  We are always available to help you through this process.

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