As you may recall, the uncertainty we faced at the end of 2010 was not resolved but only deferred via a series of extensions, most of which are set to expire in 2013. If Congress fails to adopt a more permanent tax structure before the end of this year, the income tax rates and the estate and gift taxes will revert to less-taxpayer-friendly, pre-2001 law. Adding to the uncertainty and making tax planning more challenging are two new provisions from the 2010 health care reform legislation that will take effect in 2013. Absent any Congressional action, following is a brief overview of some of the changes expected for 2013:
- The highest income tax brackets on ordinary income will increase from 33% and 35% to 36% and 39.6%, respectively.
- The maximum long-term capital gains rate will increase from 15% to 20%.
- Qualified dividends will be taxed at ordinary income tax rates instead of long-term capital gains rates.
- An additional 0.9% Medicare Hospital Insurance tax will apply to earned income (wages and self-employment income) in excess of $200,000 ($250,000 if married filing jointly). Self- employed individuals will not be permitted to deduct any portion of this tax.
- An additional 3.8% Medicare tax will also be imposed on net unearned income such as interest, dividends, royalties, rents, and passthrough income from a passive business such as S- corporations and partnerships. It does not include distributions from IRAs and 401ks.
- The estate tax lifetime exclusion rose to $5,120,000 this year and is set to revert to $1 million in 2013. The current 35% maximum tax rates for gift and estate tax purposes are also set to revert to 55%. The failure to utilize the full $5,120,000 exclusion amount prior to its lapse at the end of the year may result in the unused amount being subject to estate or gift tax at higher rates in the future.
- The current maximum one-time expense deduction for qualified new and used equipment of $139,000 (subject to phase-out) is set to revert to $25,000 in 2013.
As it currently stands, January 1, 2013 will trigger higher tax rates and additional taxes across the board for higher-income taxpayers. Assuming no legislative changes are made before then, following are some ideas to consider in anticipation of the provisions expected to be effective 2013:
- Consider realizing capital gains prior to 2013, when capital gains and unearned income tax rates are expected to increase. Additionally, if you end up in a net-capital gain position this year and anticipate the same in 2013, consider deferring recognition of capital losses until 2013, when they can be used to offset capital gains taxed at a higher rate.
- Consider rebalancing your investment portfolio by increasing investments in growth assets and decreasing emphasis on dividend-paying assets prior to 2013. This will remove income from your earnings and minimize your exposure to the unearned income tax on top of the ordinary tax rates on dividends. With higher tax rates, tax-exempt investments may produce a greater after-tax yield than taxable investments.
- Passive income will be subject to an additional 3.8% tax. If you are planning to dispose of a passive activity with suspended passive activity losses, consider whether it may be better to delay the disposition given the anticipated increase in tax rates.
- Utilize the annual gift tax exclusion every year to maximize the amount of tax-free gifts you make over your lifetime.
- Gift large amounts of cash or property this year in order to take advantage of the higher lifetime exclusion amount and transfer property today that can appreciate in value outside of your estate.
- Gift partial interests in assets through a family partnership vehicle to qualify for discounting of the gifted interest.
- A Charitable Remainder Trust is great vehicle for diversifying investments while deferring gains and receiving a charitable deduction. Consider setting one up, especially if you have highly concentrated stock, don’t need the cash, and are philanthropically inclined.
Please keep in mind that California and other states often do not conform to the federal tax laws discussed above.
Please call us to discuss any of these tax planning strategies as they relate to your specific situation.
PDF print version: Planning for 2013
Any tax advice in this communication is not intended or written by Navolio & Tallman 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 newsletter, Navolio & Tallman LLP is not rendering any specific advice to the reader.