Year-End Tax Planning Opportunities

By: Amy E. Woodward, CPA (Sep, 2012)

It’s that time of year again.  The kids are back in school, the 2012 election is in full swing, and the holidays are right around the corner.  That means it is also the time of year to start thinking about tax planning for your 2012 returns.  With a lot of economic uncertainty and an anticipated tax increase for 2013 due to a number of tax policies set to expire at the end of this year, tax planning has become more important than ever.  The sooner you start thinking about it, the more options may be available to you.

Bonus Depreciation is once again an option for business owners seeking to reduce their current year tax liability.  50% of the cost of qualified assets placed in service prior to the end of the year can be expensed.  In order to qualify, the asset must be new and have a useful life of twenty years or less.  There is currently no provision for bonus depreciation for assets placed in service in 2013, so if you have equipment that you are planning to purchase in the near future, there could be benefits to having it operational prior to year end. 

Likewise, the Section 179 deduction is available for assets purchased and placed in service during 2012.  This deduction, which can be used for new or used assets, allows you to expense the cost of assets purchased up to $139,000, with phase-outs beginning when total purchases exceed $560,000.  Section 179 limits are reduced to $25,000 with phase-outs beginning at $200,000 for 2013.  There are a couple of things to watch for when using either bonus or section 179 deductions.  The first is that while New York State allows the Section 179 deduction, New York and many other states do not allow bonus depreciation, so this option will do little to reduce your state tax burden.  Another caveat is that by taking the deduction now, you will have no depreciation available to offset the cash outflow in future years if paying off a loan used to finance an equipment purchase.

Now is a good time to start looking at year-end bonuses. The bonuses can be used to max out deferrals to your retirement plan and ensure that you have enough withheld from your paycheck to cover your estimated tax liability in April.  The maximum 401k deferral for 2012 is $17,000 with an additional contribution of $5,500 for those age 50 or older.  The maximum compensation for profit sharing plans was increased for 2012 to $250,000, with the maximum defined contribution of $50,000.  While the employee deferral must be made by December 31, the employer match does not have to be made to the plan until the due date of the returns, including extensions.  Another option for individuals is to reduce your adjusted gross income (AGI) by making a contribution to your traditional IRA (if you otherwise qualify) for 2012 by April 15, 2013.  The contribution limit is $5,000 with a catch-up contribution of $1,000 available for those age 50 or older.

One option for individuals to reduce their state income tax is through contributions to 529 Plan College Savings Programs.  Money contributed to these plans accumulate earnings tax free, and the distributions are also non-taxable when used by the designated beneficiary to pay for tuition, room and board, books, supplies and fees incurred while attending college.  Most states offer a deduction for the contribution made to the plan.  For New York State, individuals can deduct up to $5,000 of the contributions made to a 529 plan ($10,000 if married filing joint).  Contributions to out-of-state plans generally are not eligible for a deduction.

If you were thinking of gifting money or assets in the near future, you may want to make the gift prior to year end as the gift tax exemption is scheduled to go down in 2013.  While the lifetime exemption amount for 2012 is $5.12 million, this is set to go down to only $1 million on January 1st.  At the same time, the maximum tax rate on gifts will jump from 35% to 55%.  The annual exclusion for gifts remains at $13,000 per person for 2012.  A married couple can gift $26,000 to the recipient without going over the annual exclusion amount.

With the Bush tax cuts set to expire at the end of this year, individual income tax rates are scheduled to go up on January 1, 2013.  The 10% tax bracket for individuals will be eliminated with 15% once again being the lowest income tax rate.  The highest bracket will be increasing from 35% to 39.6%.  This means that it could be beneficial for individuals and pass-through entities like partnerships and S Corporations to accelerate income into 2012 to take advantage of the lower rates, and defer deductions until after year end to reduce taxable income for 2013.  The good news is that the tax rates for C Corporations will remain steady for 2013 with brackets ranging from 15% to 35%.

Tax policies regarding investments are set to change for 2013 and the capital gains tax rate is no exception.  Individuals in the 10% and 15% brackets who have been enjoying a 0% tax on capital gains will be looking at paying 10% in 2013.  Those in higher tax brackets will be paying 20% rather than 15% on their capital gains.  This means that if you have significant appreciated investments, you may want to look at selling some of them before year end to take advantage of the lower rates.  Likewise, deferring sales of investments that may result in losses until after year end may be advantageous, as they can be used to offset capital gains in future years when the rates are higher. Other changes for 2013 to taxes on investments include qualified dividends that will be taxed as ordinary income rather than at the capital gains rate, and an additional 3.8% Medicare tax on investment income that will be levied against individuals with AGI over $200,000 for single and $250,000 for married filers.

Given the lower tax brackets in 2012 compared to 2013, converting your regular IRA to a Roth IRA before year end may be advantageous. You will have to pay the entire amount of tax owed on the conversion in 2012.  However, by paying the entire amount in 2012, you will be taking advantage of the lower tax rates. Another advantage to converting this year as opposed to next year is that while income from a Roth conversion is not considered part of investment income for the additional 3.8% Medicare tax in 2013, it may increase your AGI over the income thresholds, causing your investment income to be subject to the additional tax.

With all of the tax changes on the horizon, now is the time to ensure that you are not caught by a surprise tax liability when you file your return.  With careful planning you may be able to take advantage of the variety of opportunities available to ensure you are prepared for April 15th.  Please contact your Dermody, Burke & Brown tax advisor if you have any questions regarding your year-end tax planning. 

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