Year End Tax Tips

Tax Moves to Lower Your Tax Bill

By William Perez,

There are basic year-end tax planning techniques that can be utilized to successfully manage income taxes. Year-end tax planning techniques include:

• Accelerating or deferring income.
• Accelerating or deferring expenses that can be used for tax deduction or tax credits.
• Taking advantage of any tax provisions that are scheduled to expire at the end of 2012.

All of these strategies have one factor in common: the timing of income and expenses. Accelerating means earning additional income or incurring additional tax-deductible expenses in 2012 rather than in 2013. Deferring means pushing additional income or additional deductions to 2013 rather than 2012. To the extent that income and expenses can be moved from one year to the next, these tactics can be utilized to optimize a person's tax liabilities between the years 2012 and 2013. Year-end planning is about finding the right year in which to earn additional income or to spend money on more tax deductions. For the most part, income earned in 2012 is taxed in 2012, and deductions incurred in 2012 are deductible in 2012. Finding the right year in which to incur additional income or deductions is made especially prominent in 2012 due to the large number of expiring tax provisions. Changes in store include higher tax rates and significantly altered parameters for many popular deductions and credits.
Normally, people would prefer to defer income and accelerate deductions. A year-end bonus or selling off investments can often be pushed out to the following year. If tax rates are the same in both years, the person has gained the advantage of time. If a person's overall tax rate will be lower in the following year, deferring income has the additional benefit of pushing the additional income into a year with a lower overall rate, thereby reducing tax. The same holds true for deductions, but in reverse. If a person's overall tax rate is the same in both years, accelerating deductions achieves tax savings this year rather than waiting for those tax savings to materialize next year. If a person's overall tax rate is higher in 2012 than it will be in 2013, accelerating deductions produces the additional benefit of yielding potentially larger tax savings this year rather than next year.
But what if a person's tax rate will be higher in 2013 than in 2012? Under current tax law, all the tax rates will change for 2013. Also, the two percentage point reduction in the Social Security tax is also scheduled to end. And for higher-income individuals, a new Medicare surtax will apply to wages, self-employment income and investment income. On the other hand, there are two legislative proposals in Congress to keep the tax rates the same or increase only the top two tax brackets. But so far those bills have not passed into law. Accordingly, people may want to plan out their 2012 and 2013 taxes with an eye towards the presumably higher tax rates that might go into effect in 2013. And this means that usual traditional tax planning techniques highlighted above may need to be reversed. When tax rates go up between two years, accelerating income has the benefit of locking in a lower tax rate now instead of a higher tax rate in 2013. By the same token, deferring tax deductions has the benefit of yielding potentially larger tax savings next year where the deductions can offset income taxed at higher rates, thereby squeezing extra tax dollars out of a deductible expense.

Income Deferral Strategies

A deferral strategy shifts income to a following year if tax rates in that subsequent year will be lower overall than in the current year. Common income deferral strategies include:

• Ask your employer to pay out any bonuses in January 2013 instead of in December 2012.
• Hold off on selling stocks and other investments with taxable gains until next year.
• Hold off on taking distributions from an IRA or other retirement account until January 2013.

Income Acceleration Strategies

An acceleration strategy shifts income to the current year if tax rates in the current year will be lower than in a subsequent year. Most types of income are difficult to accelerate, but some types of income are easier to shift into different years. For example:

• Ask your employer to pay out bonuses in 2012 instead of next year.
• Sell off stocks and other investments with taxable gains in 2012 instead of next year to absorb capital loss carryovers or to lock-in gains at the 15% rate.
• Accelerate IRA distributions in 2012 to avoid potentially higher tax rates starting in 2013.
• Convert pre-tax retirement savings to a post-tax Roth account to lock-in a known tax liability.

Deduction Acceleration Strategies

Accelerating deductions functions just like deferring income: the tactic attempts to reduce taxes in the current year at a higher tax rate if the overall tax rate is expected to be lower in a subsequent year. Deductions can be accelerated by:

• Paying tax deductible expenses in 2012 instead of 2013, such as medical bills, charity donations and property tax.
• Selling off stocks and other investments that have lost value so you can take the losses on your 2012 return.
• Increasing your 401(k) or IRA contributions.

Deduction Deferral Strategies

Deferring deductions attempts to delay making tax-deductible expenses until a subsequent year when tax rates are higher, and thus the deductions can produce more tax savings. For example:

• Defer paying medical bills, charity donations, property tax and other deductions until next year.
• Consider funding a Roth IRA instead of a tax-deductible traditional IRA. By forgoing the deduction, you'll be locking in a known tax rate on your contribution in return for tax-free investment returns.

AMT Tax Planning

People who are or might be impacted by the alternative minimum tax have additional considerations to think about. The AMT eliminates or reduces the federal tax savings for medical expenses, state and local taxes, property taxes, and miscellaneous itemized deductions. The suggestion here is to pay those expenses when they are due instead of trying to accelerate or defer them. For example, instead of prepaying the next installment of your property tax, wait until the actual due date to pay that since property tax is an adjustment for the AMT calculations. Similarly, anyone impacted by the AMT should sell any incentive stock options that they exercised during the 2012 calendar year since the value of an exercised but unsold ISO is added to your income for calculating the AMT. When planning for the AMT, taxpayers should be aware that the AMT could pose a bigger problem in 2012 than in 2011, as the exemption amounts for 2012 are expected to be dramatically lower in 2012, which will in turn create larger alternative minimum tax liabilities.

IRS Offers Tax Tips for “The Season of Giving”

December is traditionally a month for giving generously to charities, friends and family. But it’s also a time that can have a major impact on the tax return you’ll file in the New Year. Here are some “Season of Giving” tips from the IRS covering everything from charity donations to refund planning:

• Contribute to Qualified Charities.  If you plan to take an itemized charitable deduction on your 2012 tax return, your donation must go to a qualified charity by Dec. 31. Ask the charity about its tax-exempt status. You can also visit IRS.gov and use the Exempt Organizations Select Check tool to check if your favorite charity is a qualified charity. Donations charged to a credit card by Dec. 31 are deductible for 2012, even if you pay the bill in 2013. A gift by check also counts for 2012 as long as you mail it in December. Gifts given to individuals, whether to friends, family or strangers, are not deductible.
• What You Can Deduct.  You generally can deduct your cash contributions and the fair market value of most property you donate to a qualified charity. Special rules apply to several types of donated property, including clothing or household items, cars and boats.
• Keep Records of All Donations.  You need to keep a record of any donations you deduct, regardless of the amount. You must have a written record of all cash contributions to claim a deduction. This may include a cancelled check, bank or credit card statement or payroll deduction record. You can also ask the charity for a written statement that shows the charity’s name, contribution date and amount.
• Gather Records in a Safe Place.  As long as you’re gathering those records for your charitable contributions, it’s a good time to start rounding up documents you will need to file your tax return in 2013. This includes receipts, canceled checks and other documents that support income or deductions you will claim on your tax return. Be sure to store them in a safe place so you can easily access them later when you file your tax return.
• Plan Ahead for Major Purchases.  If you are making major purchases during the holiday season, don’t base them solely on the expectation of receiving your tax refund before the bills arrive. Many factors can impact the timing of a tax refund. The IRS issues most refunds in less than 21 days after receiving a tax return. However, if your tax return requires additional review, it may take longer to receive your refund. Refunds with EITC may be suspended up to 75 days pending review by theIRS compliance department.

What is the Fiscal Cliff? and How will it affect ME?

This paper is not intended to be political in any way but due to political gridlock in Washington DC it may sound political.   This material is solely for tax implications to the public.

The 112^th Congress, which convened on 5 January 2011, is now set to enter the record books as the least productive in a generation, passing a mere 173 public laws as of 31 Oct 2012.  That is well below the so-called do-nothing Congress of 1947-1948 that enacted 906 laws.  It’s extraordinary that with a $16 trillion debt and the threat of enormous tax increases and mindless across-the-board spending cuts that Washington hasn’t even passed a budget in three years.

Tax Increases. The bulk of the fiscal cliff, over $200 billion (per year), entails automatic tax increases, including, but not limited to, higher income tax rates for ALL wage earners, increased investment tax rates for long term capital gains and dividends, a return of the marriage penalty and higher estate and gift tax levels. This category also includes an already expired alternative minimum tax (AMT) “patch” (increased exemption), which, if not retroactively applied for 2012, could subject over 60 million taxpayers to the alternative tax for the current tax year (4 million paid the AMT in 2011).  The President’s payroll tax cut for 2011, a 2% reduction on the employee Social Security tax rate, was extended for 2012, and now expires at the end of the year. It alone costs almost $130 billion.

The IRS maintains that it cannot wait much longer to issue 2012 tax year forms without delaying the start of the 2013 filing season. Meanwhile, if the law isn't changed, the Congressional Budget Office estimates that over 60 million Americans will become subject to the AMT tax. 

So what is the Fiscal Cliff? It is a combination of the following three major events:

1.      Bush-era tax cuts expiring, extended by the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010,

2.      Federal Sequestering 40% across-the-board spending cuts take effect under the Budget Control Act of 2011;

3.      Obama Heath Care Tax implications

LOOMING DEADLINES

Effective January 1, 2013:

Payroll Tax Holiday
Take home pay will also be immediately reduced if Washington does not extend the employee-side payroll tax holiday, or enact some replacement for it. The employee-share of Social Security Tax is scheduled to return to 6.2 percent instead of 4.2 percent.  

INDIVIDUALS Income Tax Rate Increases

2012		2013
Top Income  Rate	10% to 35%		15% to 39.6%
Capital Gains	15%		23.8%*
Dividends	15%		43.4%*
Social Security Rate	4.2%		6.2%
Estate & Gift Rate	35%		55%
Estate & Gift	$5.12 MM		$1.0 MM

Personal Exemption Phase-out (PEP)
As part of the automatic sunset of Bush-era tax benefits, after 2012 higher-income taxpayers also would once again be subject to the Personal Exemption Phase-out (PEP) on itemized deductions. 

Capital Gains/Dividends
Under current law, taxpayers in the 10 and 15 percent income tax brackets pay zero percent tax on qualified capital gains and dividends.  The zero and 15 percent capital gains and dividend tax rates would increase for some taxpayers to 39.6% this represents almost a 300 percent increase when 39.6 percent rate is combined with the new 3.8 percent Medicare contributions tax on net investment income. Combined with a jump in the capital gains rate from 15 percent to 20 percent (23.8 percent with the NII tax), some economists are predicting a massive market sell-off at year end as taxpayers engage in basis-resetting strategies and reallocation of portfolio assets.

Alternative Minimum Tax
If the alternative minimum tax (AMT) exemption amounts are not patched and made retroactive for 2012, they would be dramatically less than the exemption amounts for 2011. Under current law, the AMT exemption amounts for 2012 are $33,750 for single individuals, $45,000 for married couples filing joint returns and surviving spouses, and $22,500 for married couples filing separate returns. In comparison, the AMT exemption amounts for 2011 were $48,450 for single individuals, $74,450 for married couples filing joint returns and surviving spouses, and $37,225 for married couples filing separate returns.

Child Tax Credit
After 2012, the $1,000 child tax credit is scheduled to revert to $500 per qualifying child and taxpayers who cannot take full advantage of the child tax credit because the credit is more than the taxes they owe will no longer receive this as a refundable credit.

ESTATE AND GIFT TAX

Few provisions in the Tax Code have been as uncertain in their long-term fate as the federal estate tax. In 2001, Congress set in motion a gradual reduction of the federal estate tax rate and repealed it for estates of decedents dying in calendar year 2010.

Under the 2010 Tax Relief Act, federal estate taxes again applied to estates of decedents dying after December 31, 2009, and before January 1, 2013 (although estates of decedents dying in calendar year 2010 could opt out of the federal estate tax and apply a modified carryover basis regime). President Obama has proposed extending the federal estate and gift tax under parameters in effect for calendar year 2009 for estates of decedents dying after December 31, 2012. That level would set the estate tax exclusion at $3.5 million with a 45 percent rate and the gift tax lifetime exclusion of $1 million.

Absent Congressional action, the maximum estate tax rate is scheduled to be 55 percent for estates of decedents dying after 2012 with a $1 million combined estate and gift tax exclusion amount. Opponents of the estate tax continue to maintain that it hurts family-owned businesses to the detriment of the economy.

For 2012, a unified estate and gift tax exclusion stands at $5.120 million, with a 35 percent rate imposed on the excess. The exclusion effectively becomes $10.24 million for married couples. Depending upon a wealthy individual's estate plan and the type of assets held, some practitioners recommend making large gifts before 2013 to take advantage of the $5.12 million/$10.24 million amounts that may be transferred gift-tax free before 2013.

The 2010 Tax Relief Act also provided for portability, which increases the surviving spouse's lifetime exclusion for estate and gift taxes by the portion of the deceased spouse's exclusion that is unused at the deceased spouse's death. Portability is scheduled to sunset after 2012.

Small Business Expensing
Enhanced Code Sec. 179 expensing is scheduled to expire after 2012. Unless extended, the current expensing amount of $139,000 (as indexed for inflation) is scheduled to fall to $25,000 and the current $560,000 investment limit (as indexed for inflation) is scheduled to fall to $125,000.

Bonus Depreciation
Bonus depreciation at its current 50 percent rate is scheduled to expire after 2012 (after 2013 for certain transportation property and longer-lived property). It is unclear if President Obama will support an extension of 50 percent bonus depreciation.

TAX EXTENDERS

Linked to the Bush-era tax cuts are a package of so-called tax extenders. These are popular but temporary tax incentives.

Individual Extenders

• Higher education tuition deduction
• State and local sales tax deduction
• Teachers' classroom expense deduction

• Qualified charitable distributions from IRAs
• Deduction for qualified mortgage insurance premiums
• Code Sec. 25C residential energy property credit

Note
The Code Sec. 25D residential energy efficient property credit is available for qualified property placed in service before January 1, 2017. Qualified property includes certain geothermal energy property and small wind energy property.

Business Extenders

• Code Sec. 41 research tax credit
• Code Sec. 179 small business expensing
• Work Opportunity Tax Credit (WOTC)
• 15-year recovery for qualified leasehold improvements, restaurant property and retail improvements
• New Markets Tax Credit

Note
Under current law, employers can take advantage of an enhanced WOTC for hiring qualified military veterans. The enhanced WOTC for veterans is scheduled to expire after 2012 but is a good candidate for renewal. However, it is unclear at this time if the WOTC for other target groups, which expired after 2011, will be extended.

Itemized Deduction for Medical Expenses
For tax years beginning after December 31, 2012, the Affordable Care Act increases the 7.5 percent threshold for itemizing medical expenses to 10 percent. However, the Affordable Care Act temporarily exempts individuals age 65 and older from the 10 percent threshold.  Taxpayers (or their spouses) who are age 65 or older before the close of the tax year may continue to apply the 7.5 percent threshold for tax years ending before 2017.

American Opportunity Tax Credit (AOTC)
The AOTC, which is an enhanced version of the HOPE education credit, is scheduled to expire after 2012.  If the AOTC expires, it will be replaced by the traditional HOPE education tax credit which is about one-half of AOTC and is not refundable.

Student loan interest deduction
If not extended, the incentive would only be available for the first 60 months after repayment begins and would phase-out for taxpayers with adjusted gross income between $40,000 and $55,000 ($60,000 and $75,000 for married couples filing joint returns).

Return of marriage penalty

The tax consequence of the marriage tax penalty will be reinstated (government effort to discourage marriage).  Instead of standard deduction being twice that of two single people for married couples (as it currently is today) the law would only provide a married couple 167% of the standard deduction instead of the 200% two single people would receive.

              

HEALTH CARE

President Obama's second term is expected to see the continuing implementation of the Patient Protection and Affordable Care Act (Affordable Care Act). Many tax-related provisions in the Affordable Care Act are scheduled to take effect in 2013 and beyond, including:

• 3.8 percent Medicare contribution tax (2013)
• 0.9 percent additional Medicare tax (2013)
• $2,500 contribution limit on health flexible spending accounts (2013)
• Increased threshold for itemized medical expenses (2013)
• New tax on medical devices (2013)
• State health insurance exchanges (2014)
• Individual shared responsibility payments (the individual mandate) (2014)
• Employer shared responsibility payments (2014)
• Premium assistance tax credit (2014)
• No annual dollar limits on health insurance coverage (2014)
• Increase in small employer health insurance tax credit (2014)
• New tax on "Cadillac" health insurance plans (2018)

Note
The U.S. Supreme Court upheld the Affordable Care Act's individual insurance mandate in NFIB v. Sebelius, 2012-2 ustc ¶50,573. However, opponents argue that the employer's shared responsibility payment was not addressed by the Court in NFIB v. Sebelius. Some taxpayers have also challenged the Affordable Care Act's contraceptive provisions.

Health Flexible Spending Arrangements
After 2012, the Affordable Care Act caps the maximum salary reduction contribution to a health flexible spending arrangement (health FSA) at $2,500. Salary reductions in excess of $2,500 will subject the employee to tax on distributions from the health FSA. The $2,500 limit will be indexed for inflation for tax years beginning after December 31, 2013.  Effective January 1, 2011, the Affordable Care Act prohibited health FSA dollars from being used to reimburse the cost of over-the-counter medicines (except insulin).

Medical Devices
The Affordable Care Act imposes a 2.3 percent excise tax on the sale of qualified medical devices by manufacturers, producers and importers after December 31, 2012.

Below is a detailed chart explaining Major Bush Tax Cuts and other tax items that are expiring or have already expired earlier in year 2012.

Major Bush Tax Cuts Provisions Expiring at the End of 2012
IRS Code	2012 Provision	2013 Provision                                                  Without Congressional Action
§1 (income tax brackets)	Income tax brackets are:                                                                                   10, 15, 25, 28, 33, 35%	Income tax brackets are 15, 28, 31, 36 and 39.6% (with a marriage penalty returning - the 15% bracket for taxpayers filing joint returns as well as qualified surviving spouses being 167% of the 15% bracket rather than 200%)                                                                                           [Note:  Dividends paid to individuals taxed at ordinary income rates]
§1(g)(7)(B)(ii)	Inclusion of child's gross income exceeding set amount plus 10% of lesser of (a) inflation-adjusted standard deduction for dependent child, or (b) excess of child's gross income over amount in (a)	10% figure changes to 15%
§1 (h) (capital gains)	0% for those in the 15% bracket and lower; 15% for taxpayers in higher brackets	10% for lower income taxpayers; 20% for taxpayers in higher brackets
§21 (credit for household and dependent care expenses)	$3,000 for 1 qualifying individual, and $6,000 for 2 or more; maximum credit percentage of 35% and AGI-based reduction starting at $15,000	$2,400 for 1 qualifying individual, and $4,800 for 2 or more; maximum credit percentage of 30% and AGI-based reduction starting at $10,000
§24 (child tax credit)	$1,000 per qualifying child and is allowed against the AMT	$500 per qualifying child with no allowance against the AMT
§32 (earned income tax credit)	Earned income and AGI must be less than $19,190 (MFJ) for taxpayers with no qualifying children and $50,270 (MFJ) for taxpayers with 3 or more qualifying children	Beginning of phase-out range lower; phase-out of credit computed with reference to MAGI rather than AGI; earned income includes exempt income; EITC reduced by AMT; credit maxes out with 2 dependents
§36C (adoption credit) goes back to §23	$10,000 maximum credit                                                                          $12,650 ($10,000 statutory amount as adjusted for inflation)	Maximum credit lower; eligible expenses limited; reduced phase-out range; inapplicable against AMT; available only for special-needs child.
§45F (credit for employer provided child care facilities)	Available	Unavailable
§63 (standard deduction)	Married taxpayers get 200% of the standard deduction that applies for single taxpayers	Married taxpayers get 167% of the standard deduction that applies for single taxpayers
§68 (overall limitation on itemized deductions)	Pease limitation not applicable in 2012	Greater limitations apply; for higher-income taxpayers, itemized deductions are reduced by 3% of AGI above a certain amount with reduction not exceeding 80%
§127 (exclusion for employer provided educational assistance)	Available	Unavailable; also gone is the allowance of the exclusion tied to graduate-level education; expenses paid by employer for education or training provided to the employee excluded only if qualified as working condition fringe
151(d) (phase-out of personal exemptions)	Set level	Phase-out for higher income taxpayers
§221 (above-the-line deduction for student loan interest)	Available	Available, but reduced phase-out range and applicable just to interest paid during first 60 months of required interest payments
§530 (Coverdell Education Savings Accounts)	Available	Contribution limit $500; lower phase-out range for MFJ; applicable only for higher education expenses; no special rules for special needs beneficiaries; no rule allowing corporations (and other entities) to make contributions; can't make contributions for current year by April 15 of following year
Major Bush Tax Cuts Provisions Expiring at the End of 2012 (continued)
IRC	2012 Provision	2013 Provision                                                  Without Congressional Action
§§531 and 541                              (accumulated earnings tax rate and personal holding company tax rate)	15%	39.6%
§2001 (estate tax)	35% rate of tax on taxable amounts above $5.12 million	55% rate on taxable amounts above $1 million; reinstatement of §2057 family-owned business deduction; reinstatement of credit against state death tax
§2505 (gift tax)	35% maximum rate; $5.12 million exemption (unified credit exemption equivalent)	55% maximum rate with $1 million exemption (unified credit exemption equivalent)
§2631 (generation-skipping transfer tax)	35% maximum rate	55% maximum rate above an exemption of between $1,360,000 - $1,430,000 (to be determined based on an inflation adjustment)
§3402 (backup withholding on gambling winnings)	25% rate	28% rate
Other Tax Law Provisions Expired at the beginning of 2012 and have yet to be reinstated
IRC	Provision
§25C	Nonbusiness energy property credit
§36C	Refundability of adoption credit
§41(h)(1)(B)	Research credit
§45L	Credit for construction of new energy efficient homes
§45M	Energy efficient appliance credit
§51(c)(4)	Work opportunity tax credit for non-veterans
§62	$250 above-the-line deduction for specified expenses of elementary and secondary school teachers
§163(h)(3)(E)	Ability to treat mortgage insurance premiums as deductible qualified residence interest
§164(b)(5)	Election to deduct state and local general sales taxes in lieu of state and local income tax deduction
§168(e)	15-year depreciation for qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement
§168(i)(15)(D)	7-year straight-line depreciation for motorsports entertainment complexes
§168(k)(1) and (5)	100% first-year bonus depreciation (reduced to 50% for 2012)
§170(b)(1)(E); (b)(2)(B)	Tax incentives for contributions of capital gain real property for conservation purposes
§170(e)(3)(C)	Enhanced charitable deduction for contributions of book inventories to government schools
§170 (e)(6)(G)	Corporate contributions of computer equipment for educational purposes
§179	Expense method depreciation ($139,000 for 2012 with investment ceiling of $560,000)
§181(f)	Election to expense production costs of qualified film and television products in the U.S.
§408(d)(8)	Tax-free distributions up to $100,000 annually for taxpayers over age 70-1/2 from an IRA for charitable purposes
§613A(c)(6)(H)(ii)	Suspension of income limitations on percentage depletion for marginal wells
§1202	Exclusion of gain on certain small business stock (only 50% for 2012 and 60% for qualified business entity stock as defined by the statute)
§1367(a)	Lower shareholder basis adjustments for charitable contributions by S corporations
Some  Code Provisions Expire at the end of 2012 outside of Bush Tax Cuts
IRC	Provision
§25A(i)	American Opportunity Tax Credit - credit basically cut in half (maximum credit becomes 100% of first $1,000 of qualified tuition and related expenses, and 50% of next $1,000 of qualified tuition and related expenses); other expiring provisions include the enhanced AGI limits, the reduction of the refundable portion, and the elimination of the course materials credit allowance
§51(c)(4)(B)	Work Opportunity Tax Credit inapplicable with respect to qualified veterans hired after 2012
§53(e)	Refundable credit for unused AMT credit
§108(a)(1)(E)	Exclusion for qualified principal residence debt that is discharged
§§168(k)(1) and (k)(4)	50% first-year bonus depreciation; election to accelerate AMT credits in lieu of claiming bonus depreciation
§179	Expense method depreciation - amount will be $25,000 in 2013 and investment ceiling will be $200,000
§§3101 - 3111	Payroll tax cut expires - 4.2% (employee OASDI tax) becomes 6.2%; 10.4% (self-employed OASDI rate under SECA) becomes 12.4%