Year-end Tax Planning Tips for U.S. High Income Earners
Thomson Reuters tax analyst discusses strategies for these taxpayers
Tax laws are scheduled to change once again in 2013. However, 'There's still time to take advantage of favorable 2012 tax rates and laws and get ahead of higher projected tax rates in 2013,' said Jim Van Grevenhof, a senior tax analyst for Thomson Reuters. 'Time is of the essence, however, because the window of opportunity is closing quickly and the 'fiscal cliff' is looming.'
Below, Van Grevenhof describes some of the more significant 2012 tax issues and strategies for minimizing tax liabilities.
First, let's look at planning ideas to avoid or minimize two fairly certain tax increases in 2013.
New 3.8 Percent Medicare Contribution Tax. As a component of recent healthcare legislation, beginning in 2013 there is a new 3.8 percent Medicare Contribution Tax. This tax is levied on the lesser of (a) net investment income or (b) the excess of modified adjusted gross income (MAGI) over certain threshold amounts ($250,000 for joint returns, $125,000 for married separate returns, and $200,000 for all other taxpayers).
Taxpayers can eliminate or minimize this new tax by decreasing MAGI or net investment income, or both, in 2013. Tax reduction strategies include structuring the receipt of bonus, profit sharing, or other incentive payments in 2012 versus 2013; selling investment assets with built in gains in 2012 instead of 2013; and selling property on an installment basis in 2012 and, in conjunction, electing out of the installment method to recognize the entire gain in 2012.
New 0.9% Medicare Surtax. Beginning in 2013, recent healthcare legislation also provided a new 0.9 percent Medicare Surtax. This tax is imposed on wages and self-employment (SE) income in excess of specific MAGI threshold amounts ($250,000 for joint returns, $125,000 for married separate returns, and $200,000 for all other taxpayers). Taxpayers can eliminate or minimize this new surtax by implementing strategies to reduce SE income earned after 2012.
One strategy is to accelerate SE income that normally would have been earned in 2013 (and, therefore, subject to the 0.9 percent Medicare surtax) into 2012. Cash-method sole proprietors may be able to accelerate taxable income into 2012 by invoicing clients as soon as feasible, so that proprietors receive payment for them in late 2012. They may also be able to defer deductible expenses into 2012 by waiting to pay deductible business expenses such as office supplies and repairs and maintenance until next year. Also, a taxpayer who is an employee of a family-owned business that will pay a bonus for this year might want to get it paid in 2012, rather than waiting for 2013.
'Beginning in 2013, taxpayers might consider leasing real property to the taxpayer's closely held business, renting business property to a proprietor spouse, employing family members in the business, and, in certain situations, adopting a self-insured medical reimbursement plan,' advised Van Grevenhof. 'All these can help to minimize SE income.'
Next, let's look at provisions of the 2001 and 2003 tax cuts set to expire at the end of 2012. Some or all may be extended in their present or a modified form. However, without Congressional action, these favorable provisions will expire on December 31 and tax rates will increase in 2013.
Current 15 Percent Capital Gains Rate in 2012. The maximum rate on long-term capital gains is scheduled to increase from 15 percent to 23.8 percent (20% + 3.8%) in 2013. Taxpayers can use various strategies to minimize the effect of this increase, including harvesting built-in gains during 2012, deferring sales of investment loss assets until 2013, and electing out of the installment sale method for gains incurred during 2012.
Current 15 Percent Maximum Rate on Qualified Dividends. The maximum tax rate on qualified dividends is scheduled to increase from 15 percent to 43.4 percent (39.6% + 3.8%) in 2013. Taxpayers can minimize the impact of higher 2013 tax rates by maximizing the payment of dividends from closely held domestic C corporations in 2012.
Maximum Tax on MRDs. The maximum tax rate on the taxable portion of an IRA minimum required distribution (MRD) will increase from 35 percent to 39.6 percent in 2013. Taxpayers turning 70½ in 2012 should consider taking their initial MRD in 2012 versus 2013.
Maximum Rate on Roth Rollovers. The rate on the taxable portion of a traditional to Roth IRA rollover will increase from 35 percent to 39.6 percent in 2013. Taxpayers contemplating the conversion of a traditional IRA to a Roth IRA should consider completing the transaction in 2012 to avoid the higher projected 2013 tax rates.
Defer Large Charitable Contributions. Higher tax rates will increase the value of charitable contributions in 2013. Taxpayers can defer large charitable contributions from 2012 to 2013 and obtain a larger tax benefit from the contribution next year.
Taxpayers should consult with a tax advisor before applying these or other tax strategies.
Up-to-date analyses of legislation and regulations affecting taxpayers are available on the industry-leading, award-winning Thomson Reuters Checkpoint research platform.
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