The new year will likely bring great uncertainty when it comes to taxes. The vast amounts of ambiguity spring, at least in part, from the federal government”™s recent struggles to deal with the economic downturn and our slow recovery. Tax rates that were lowered to boost the economy are set to go back up and breaks designed for the same purpose are headed for expiration.
For example, both ordinary income and capital gains tax rates are scheduled to increase in 2013 (see accompanying chart). Meanwhile, a number of tax breaks have been designated for elimination in 2013. These include the personal exemption and itemized deduction phaseout repeal, the higher contribution limits for Coverdell Education Savings Accounts and the American Opportunity education credit.
If you”™re the optimistic sort, you might respond by saying, “What”™s the big deal? Congress will just extend all of these rates and breaks as usual.”
Granted, it might. Or there could be another significant tax bill on the way. But it”™s even harder than usual to predict what will happen in the coming months because of the increased focus on the budget deficit and the fact that it”™s an election year.
And, while some of the advantageous rates and breaks don”™t expire until after 2012, a wide variety of tax-planning strategies depend on looking ahead at not only the rest of the current year but also the next year. Your goal is to time income and deductions to your advantage. Yet doing so is more difficult when there”™s so much uncertainty about what tax rates will apply and what breaks will be available either this year or next.
Traditional tax planning often calls for deferring income to the next year and accelerating deductions into the current year in order to defer tax. But these steps could be costly if rates go up, because you”™ll be pushing taxable income into a year when it will be subject to a higher tax rate. In addition, deductions are more valuable when your rate is higher.
Although there”™s no tax-savvy crystal ball that can tell you precisely what”™s going to happen, you do have plenty of coping measures worth considering:
Sell long-term appreciated assets before the favorable 15 percent capital gains rate jumps to 20 percent. This could be an especially beneficial move if you”™ll also likely be subject to the new Medicare tax on gains next year (see sidebar).
Accelerate income into 2012, where possible. Doing so will help you take advantage of the lower ordinary rate. If you”™ll be subject to deduction phaseouts in 2013, consider whether it would make sense to also accelerate deductible expenses into 2012 while the phaseout is repealed.
There are some caveats to these tips and others you may ponder. First, beware of the alternative minimum tax (AMT). Actions that are advantageous for regular income-tax purposes could trigger it.
Also, as contradictory as this may sound, don”™t think only about taxes. It”™s important to consider other factors, such as your degree of financial security, your financial needs and goals, and your risk tolerance.
| Tax rates scheduled to increase | |
| 2012 | 2013 |
| Regular income tax rates | |
| 10% | 15% |
| 15% | 15% |
| 25% | 28% |
| 28% | 31% |
| 33% | 36% |
| 35% | 39.6% |
| Long-term capital gains rates* | |
| 15% | 20% |
* Different rates apply in some situations.
Norman G. Grill Jr. is managing partner of Grill & Partners L.L.C., certified public accountants and advisers with offices in Fairfield and Darien. Reach him at N.Grill@GRILL1.com.
New Medicare tax could shock you
The Patient Protection and Affordable Care Act of 2010 is bringing many changes to the health care landscape. But some people may be in for a shock when they learn that, starting in 2013, the act could drive up their tax liability as well. Under the act, higher-income taxpayers will be subject to two new Medicare taxes:
- An additional 0.9 percent tax on wages and self-employment income that exceed specified thresholds, and
- A new 3.8 percent tax on net investment income to the extent their modified adjusted gross income exceeds those same thresholds.
Feeling the effect of these two new taxes will be single filers and heads of households earning $200,000 or more, married taxpayers filing jointly earning $250,000 or more, and married taxpayers filing separately earning $125,000 or more. As you can see, a “marriage penalty” appears to be in place for some couples.
Until now, Medicare taxes have never applied to investment income or other “unearned” income. So this is definitely something new to prepare for if you”™ll likely exceed these income thresholds in 2013.
But keep an eye on the Supreme Court, as well as Congress. The court has agreed to review a case regarding the constitutionality of the act and Congress might also again try to repeal it, or at least some of its provisions.
