With less than 30 days left in 2012, there is still time to do some year-end tax planning. This 2012 tax year is more difficult in that no one knows how the tax laws may change before the end of the year. With certain tax deductions and credits due to expire at the end of 2012 (sunset provisions) and new higher tax brackets kicking in next year (end of the Bush-era tax cuts), year-end tax planning is harder than ever.
However, income tax planning must go on even in this uncertain tax environment. As a result, it is essential to know the customary year-end planning techniques that cut income taxes.
It all starts with a tax projection of whether you will be in a higher or lower tax bracket next year. Once your tax brackets for 2012 and 2013 are known, there are two basic income tax considerations:
Example: For income taxed at a higher tax bracket next year, accelerating such income to 2012 results in less taxes being paid. At the same time deductions and tax credits deferred into next year will become more valuable as they offset income taxed at a higher bracket.
However, life is never that simple. Tax law uncertainty, especially this year, makes for some real guesswork. As discussed below, when it comes to certain deductions that have tax threshold limitations, bunching of deductions to one year may force the timing into a tax year where the tax bracket is lower than the other tax year in question. Year end tax projections must take into account the maddening alternative minimum tax.
In any event, the following lays out the basic ideas for income acceleration and deduction/credit deferral in a rising income tax bracket environment.
For taxpayers who think that they will be in a higher tax bracket, here are some targeted forms of income to consider accelerating into 2012.
Example: Mr. Appreciation has low basis stock that has appreciated by $200,000 as of December, 2012. He thinks he will need to liquidate his positions either this year or next. His $200,000 gain will generate $30,000 in federal taxes in 2012 (15% tax). If Mr. Appreciation waits until 2013, the tax rate may be 25% (or more due to the 2013 higher capital gain rate and 3.8 percent surcharge and itemized deduction limitations) with a tax of $50,000 in 2013. As a result, a sale in 2012 may save $20,000.
Note, however, that for an older taxpayer or one in ill-health, this strategy may not make sense since there would be no capital gains (because of the step up in basis rules) if the assets passed through his or her estate.
Planning Note: The wash sale rules do not apply when selling at a gain, so taxpayers can cash out their gains and then repurchase the securities immediately afterwards.
Example: Do not prepay state and local income taxes or property taxes if subject to the AMT. It will generate no income tax benefit.
Remember that these are some of the customary year-end income tax strategies and are not all-encompassing. Taxpayers must take into account slated tax law changes for next year and last-minute tax laws enacted before year-end. Accelerating tax payments must take into account the impact on cash flow and the present value of money. This is why it is essential to “run the numbers” to find the best steps to reduce the impact of these new tax laws.
Also keep in mind that recent tax law changes, like the 3.8 medicare tax that applies to 2013, bear heavily on income tax planning. For more details please read 2013 Sneaky New Tax – Not Too Early to Plan for 3.8 % Medicare Tax on Investment Income.
Most importantly remember that income tax strategies depend on the specific income or expenses of each taxpayer and their overall income, gift and estate tax setting. This discussion offers some but not all tax strategies.
As always, it is quite beneficial to have tax counsel look at the details of your particular income tax situation to carve out specific tax strategies to cut taxes owed.
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