2012 Year-End Tax Planning for Individuals and Businesses

As 2012 is coming to a close, now is an ideal time to start preparing for all the available opportunities to reduce your tax burden. With the level of uncertainty looming over what 2013 will bring, planning is all the more important as you and your advisors strategize on the best approach. This article will encapsulate the 5 most significant tax reforms impacting 2012 and 2013.

There have been some key changes over the past year with the Supreme Court upholding the Patient Protection and Affordable Care Act (Act) and a number of the Bush tax cuts set to expire by year end. There is time, however, to take advantage of the tax breaks available to you now. Planning for these changes and more can help you have the best strategy in place for the coming tax season.

Supreme Court Upholds the Patient Protection and Affordable Care Act

How does this affect individuals?
One big change, not only for the coming season, but in years to come is the provisions of the Patient Protection and Affordable Care Act. To support the cost of the Act, high-income taxpayers will face a higher tax burden. Starting in 2013, those with earned income more than $200,000 ($250,000 for joint filers) will pay an additional 0.9% Medicare surtax on the earned income in excess of the threshold. Taxpayers with adjusted gross income over $200,000 ($250,000 for joint filers) will pay a new 3.8% Medicare surtax on net investment income such as interest, dividends, rents, royalties and certain capital gains in excess of this threshold.

One strategy for reducing or mitigating the 3.8% Medicare surtax is by treating real estate activities as active. Real estate investors should research the active real estate investor rules to determine if they might be able to minimize the Medicare surtax by classifying their real estate investments as active.

Another strategy for reducing the Medicare surtax is to make deductible contributions to a traditional IRA, lowering modified adjusted gross income (MAGI). Individuals aged 50 and younger are able to contribute $5,000 maximum and those aged 50 or older are able to contribute $6,000 maximum on an annual basis.

Wealth transfer planning may help mitigate the cost of the surtax to wealthy individuals, as the gift of primary income or net income producing property will transfer the asset from the donor, thereby reducing overall net income. A similar strategy can be used to give to charity — gifting income or property to a charity can reduce the donor’s net income.

Lastly, installment sales can help high income individuals limit their annual net investment income and thereby manage their MAGI. An installment sale is a type of sale in which an asset is sold in exchange for a promissory note that is paid in increments over an allotted period of time.

How does this affect businesses? 
This Act not only affects individual citizens, but has an impact on businesses as well. Currently, the Act does not require employers to provide insurance coverage, but starting in 2014, it will place penalties on certain employers that do not provide health coverage. Employers with 50 or more full-time-equivalent workers (FTEs) that do not offer coverage and have at least one full-time employee who receives a premium tax credit are subject to an annual fee of $2,000 per FTE (not including the first 30 FTEs).

On the flip side, this year small businesses are entitled to tax credits for purchasing group health coverage. For tax years 2010 to 2013, the maximum credit is 35% of premiums paid, provided the employer contributes at least 50% of the total premium or 50% of a benchmark premium. Starting in 2014, a maximum credit of 50% of premiums paid is available for two years for employers that purchase coverage through a state exchange and contribute at least 50% of the total premium. Smaller credits are available for tax-exempt businesses.

Continued Low Capital Gains and Qualified Dividend Rates
Another helpful strategy to consider this year is to take advantage of the continued low capital gains and qualified dividend rates available through December 31, 2012. Currently, the 15% long-term capital gains rate is slated to go back to 20% in 2013. The lower rate also applies to qualified dividends, which are scheduled to go back to being taxed at your marginal ordinary-income rate. This could be as high as 39.6%. In anticipation of these higher rates, consider whether you should sell highly-appreciated assets that you’ve held long term in order to avoid paying capital gains at a higher rate next year. If you have investments that produce dividends, this is an ideal time to consider adjusting your portfolio before tax rates increase next year.

Take Advantage of the Increased Gift Tax Limit
Estate planning is an important ingredient to year-end planning strategies this year, as there are favorable exemptions and rates that are scheduled to expire in 2013. The lifetime gift tax exemption is set to drop significantly after December 31, 2012. Currently, there is no gift tax on lifetime gifts up to $5,120,000. In 2013, the lifetime gift tax exemption is expected to drop to only $1,000,000. In addition, the estate tax rate is set to increase from 35% to 55% in 2013.

With the exemption at an all-time high and rates at an all-time low until year-end, now is the time to plan before the possibility of changes occurring in 2013.

2012 Brings Expansion of Enhanced Third-Party Reporting

How does this affect individual taxpayers?
In 2011, brokerage firms had to start reporting basis information for certain stock transactions, and for 2012, there are additional types of transactions that will fall under the basis reporting requirements. Brokerage firms will now have to provide reporting for mutual funds, dividend reinvestment plans and some exchange-traded funds that were acquired on or after January 1, 2012.

While having the brokerage firm track and report cost basis may seem like it will make things easier, it is important that taxpayers retain their own records to be sure what their broker reports for cost basis is accurate. Additionally, you will need to make sure that the amount you put on your return is the same figure.

With these newly enhanced requirements for third-party reporting, it is recommended that taxpayers keep clear records of stock transactions and speak with a tax professional to understand the options surrounding how to calculate cost basis.

How does this affect businesses?
Starting in 2012, the new Form 1099-K Payment Card and Third Party Network Transactions, originally introduced in 2011, will need to be reported separately by recipients on their business and rental returns. This will require additional reconciliation and compliance on the taxpayer’s side. The 1099-K is sent out by credit card companies to report business transactions to the IRS, so not only will businesses need to reconcile their credit card income on Form 1099-K, but they will also need to ensure expenses are separated out from that income. Monitoring these forms is important to ensure there is no double reporting between the credit card company and their customers, resulting in an over reporting of income.

50% Bonus Depreciation and Increased Sec. 179 Expensing
Businesses that have made asset purchases, or are considering them, may want to take advantage of the 50% bonus depreciation that is set to expire on December 31, 2012. Qualified assets include new tangible property with a recovery period of 20 years or less (such as office furniture and equipment), certain computer software, water utility property and qualified leasehold-improvement property.

Additionally, businesses could consider Section 179 expensing to deduct up to $139,000 on qualified new and used equipment that was purchased and put into service in 2012. If eligible, planning for this could allow you to deduct 100% of an asset’s acquisition cost.

If you strive to get the best tax outcomes, the time to start planning is now. Bartlett, Pringle & Wolf, LLP is committed to helping you navigate the tax planning process to meet your goals. As always, we are here to assist you in every step along the way. If you have any questions, please contact me at (805) 963-7811 or bforeman@bpw.com.