2012 Year-End Tax Planning
Federal Tax Outlook for Individuals for 2012 and 2013
At the end of 2012, many of the tax provisions set forth in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act (“TRA 2010”) are set to expire. Unless Congress acts, taxpayers will face higher tax rates on their income for the year 2013. Among the most significant of these changes will be a higher overall maximum tax rate on ordinary income, a new Medicare surtax on net investment income, and the sunset of lower rates on long-term capital gains and qualified dividends. As a result, year-end tax planning has become especially important for 2012.
This chart compares current tax rates for 2012 to the expected tax rates for 2013 and beyond, barring any new legislative changes. It also covers key changes in exemption and exclusion amounts.
|Comparing 2012 and 2013 Tax Rates and Figures|
|Income Tax Maximum Rate||35%||39.6%2|
|AMT Maximum Rate||28%||28%2|
|Medicare Tax on Wage Income Over $250,000||0%||0.9%|
|Medicare Surtax on Net Investment Income (Applies to Modified Adjusted Gross Income Over $200k for Single and $250k for Married Taxpayers)||0%||3.8%|
|Maximum Long Term Capital Gains Rate||15%||20%2|
|Qualified Dividend Rate||15%||39.6%2|
|Estate Tax Exemption||$5,120,000||$1,000,000 2|
|Estate Tax Maximum Rate||35%||55%2|
|Gift Tax Exemption||$5,000,000||$1,000,000 2|
|Gift Tax Maximum Rate||35%||55%2|
|Annual Gift Tax Exclusion||$13,000||$14,000|
1 Barring any legislative changes
2 In 2013, the exemption amounts and rates will return to pre-2001 amounts.
There are a number of interrelated changes affecting the tax outlook. Due to the complexity and uncertainty involved, we would encourage you to speak with your tax advisor before making any major strategic decisions.
California Proposition 30 Passes
Voters in California passed Proposition 30, the Sales and Income Tax Increase initiative led by Governor Jerry Brown. This proposition increases California personal income tax rates on upper-income taxpayers for seven years, retroactive from January 1, 2012. The measure increases the maximum tax rate in California from 10.3% to 13.3%, which will apply to tax years through 2018. This tax rate includes the 1% Mental Health Services tax already in effect on taxpayers whose taxable income exceeds $1,000,000. Proposition 30 also increases the state sales tax rate by one-quarter cent for every dollar, for four years.
|Current and Proposed Personal Income Tax Rates under Proposition 30|
|Single Filer’s Taxable Income||Joint Filer’s Taxable Income||Current Marginal Tax Rate||New Marginal Tax Rate|
|$250,000 – 300,000||$500,000 – 600,000||9.30%||10.30%|
|$300,000 – 500,000||$600,000 – 1,000,000||9.30%||11.30%|
|$500,000 – 1,000,000||n/a||9.30%||12.30%|
|Over 1,000,000||Over $1,000,000||10.30%||13.30%||*|
|* Note 1% Mental Health tax for CA taxable income over $1,000,000|
Sunset of Reduced Federal Capital Gains Tax
For 2012, taxpayers below the 25% bracket pay no tax on capital gains, and taxpayers in the 25% bracket and above pay a 15% tax on capital gains. In 2013, lower-income taxpayers will pay a maximum rate of 10% (8% if the asset is held over five years and purchased after January 1, 2001) on capital gains. Taxpayers in the 25% tax bracket and above will be taxed at a rate of 20% (18% if the asset is held over five years and purchased after January 1, 2001) on capital gains. Also, beginning in 2013, a 3.8% surtax will apply to certain unearned investment income exceeding $250,000 for joint filers. This will make the potential maximum federal tax rate for capital gains 23.8%, plus any applicable state tax. Please refer to Medicare Surtax below for more information. It is possible the long-term capital gain rate may still qualify for 8% or 18% treatment if the asset was purchased prior to 2001 and a deemed-sale election was made.
Sunset of Federal Qualified Dividends Rate
For 2012, the tax rate on qualified dividends has been the 15% rate assessed for net adjusted capital gains. However, in 2013, the qualified dividends provision is scheduled to sunset, after which dividends will be taxed at the individuals’ ordinary tax rate, ranging from 15% to 39.6%. Including the Medicare surtax, the potential maximum tax rate for dividends will be 43.4% plus applicable state tax. Please refer to Medicare Surtax below for more information.
A new Medicare surtax goes into effect January 1, 2013. Individuals will be subject to a tax equal to 3.8% of the lesser of net investment income or the excess of their modified adjusted gross income (MAGI) over a threshold ($200,000 for those filing singly and $250,000 for those filing jointly). Types of income generally included in “net investment income” are interest earnings, dividends, capital gains, annuities, royalties, rents, and all income from a trade or business in which you do not materially participate.
Limits on Itemized Deductions
In 2012, there is no phase-out for itemized deductions for taxpayers at any amount of adjusted gross income (AGI). In 2013, however, an “automatic” tax law rollback will revive the phase-out provisions that existed prior to 2010.
For taxpayers whose adjusted gross income (AGI) surpassed certain thresholds, itemized deductions were generally reduced by 3% of the excess of AGI over the $166,800 3 ($83,400 3 for married filing separately) threshold amount until up to 80% of allowable itemized deductions were eliminated.
In 2012, the threshold for medical expense deductions is 7.5% of AGI. The threshold will be increased to 10% in 2013 for taxpayers under the age of 65.
3 2009 tax year threshold amounts will be adjusted for inflation.
Roth IRA Conversion
During 2010, the removal of previous limitations on taxpayers with AGI over $100,000 allowed wealthier taxpayers to convert their traditional IRA to a Roth IRA without tax penalties. The AGI limitation removal may have significant tax benefits given the upcoming tax rate changes in 2013. Before you convert to a Roth IRA, you should review your financial situation and consider your expected retirement income from other sources and your anticipated tax rates during retirement. If you determine that you are a candidate for a Roth IRA conversion, you would then pay income tax on the amount being converted in the conversion year.
New Foreign Asset Reporting Requirements
In 2011, individual taxpayers were required to report specified foreign financial assets (both in accounts as well as held directly) if the value of such assets exceeded $100,000 or more on the last day of the year or $150,000 at any time during the year, for married filing joint taxpayers.
In 2012, temporary and proposed regulations would expand this reporting requirement to include corporations, partnerships, and certain trusts owning foreign assets with values in excess of $50,000 or more on the last day of the year or $75,000 at any time during the year. These regulations were added through the Foreign Account Tax Compliance Act (FATCA) provisions of the Hiring Incentives to Restore Employment Act. For complete analysis of FATCA, please visit here.
Summary of Tax Outlook for 2013 and Beyond
In 2013, many tax rules are scheduled to change as legislation expires on December 31, 2012. Unless Congress passes new legislation to extend tax cuts and raise exemption amounts for the AMT, estate tax, gift tax, and generation-skipping tax, these amounts will return to pre-2001 levels.
Barring new legislation, here is a summary of the changes to tax rates, as well as other important tax figures for 2013:
- The 33% and 35% tax brackets will increase to 36% and 39.6%, respectively.
- Long-term maximum capital gain rates will increase from 15% to 20%.
- All dividends will be taxed at ordinary rates.
- A newly levied 3.8% Medicare surtax on either net investment income or income over the MAGI threshold will go into effect for individuals with modified adjusted gross income (MAGI) over $200,000, married couples with MAGI over $250,000, and trusts with MAGI over $12,000.
- Additional 0.9% Medicare surtax will be owed on wages over $250,000.
- Phase out for itemized deduction will begin over a certain AGI threshold. Itemized deductions will be reduced by the 3% of the taxpayer AGI over the threshold, with the reduction not to exceed 80% of otherwise allowable itemized deductions.
- The annual gift tax exclusion amount will be $14,000 per recipient.
- The Social Security wage base will increase from $110,100 in 2012 to $113,700 in 2013.
If the current tax laws are not changed or updated, 2013 will see higher marginal tax rates and limitations on itemized deductions.
Other significant changes to the tax laws for the year 2013 are:
- Deduction of state and local sales tax will no longer be allowed.
- Deduction of student loan interest will no longer be allowed.
- The American Opportunity college education credit will expire.
- Income tax exemption for debt forgiven on home foreclosures and repossessions ends.
- The child care deduction limit of $3,000 will revert to $2,400.
In short, now is the time to take a focused look at your financial position and future goals. You’ll find additional tax-related articles to keep you informed, including Year-End Planning: Private Foundations (as well as articles on a variety of additional financial topics) here in our online library. It is always prudent to discuss important decisions with your tax advisor, and we encourage you to engage in discussions your financial position and future goals on a regular basis throughout the year.
Any tax advice in this communication is not intended or written by Frank, Rimerman + Co. LLP to be used, and cannot be used, by a client or any other person or entity for the purpose of (i) avoiding penalties that may be imposed on any taxpayer, or (ii) promoting, marketing, or recommending to another party any matters addressed herein. With this alert, Frank, Rimerman + Co. LLP is not rendering any specific advice to the reader.