guest commentary by David Potts
Potts is a certified public accountant with more than 25 years experience (Although every effort is made to provide you accurate and timely tax information, it is general in nature and not specific to your facts and circumstances. Consult a qualified tax professional to discuss your particular case.)
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This summer the subject of income taxes has triggered much talk, mixed with misinformation and demonstrations of anxiety. The first half of the year we had to wait to see whether the Patient Protection and Affordable Care Act and its related tax provisions are constitutional.
Now that we know it is constitutional, we have to wait to find out if President Obama and Congress will extend the “Bush era tax cuts” for people with incomes under $250,000.
But what do we believe? Being an election year it is certain we will hear many promises from politicians that will not be kept. With this uncertainty, we are left to ponder whether an investment of time in tax planning is beneficial or futile. Will you develop a tax plan on the wrong set of assumptions?
Tax planning is probably more beneficial this year than many past years because of this uncertainty our government has imposed on us. With all this talk of tax changes and increases, a person might become numb to all this information and might prefer to play with a slinky for several hours instead.
But if you're really interested in reducing your income tax bill, playing with a slinky is the wrong choice. The right choice is to begin your income tax planning while there is still time to initiate transactions in your favor.
In this time of uncertainty some things are certain. It is certain, beginning January 1, 2013, that the Medicare tax imposed on earned income will increase 0.9% for individuals with incomes greater than $200,000 and for married couples with incomes greater than $250,000. Of course the real kicker for these individuals is that for the first time in our history, the total Medicare tax rate of 3.8% will be applied to net investment income. Net investment income includes income from interest, dividends, annuities, royalties, rents, business income from passive investments, and gains from certain property sales.
If your income exceeds the limits above, you should be cynical about whether the Bush era tax cuts will be extended for you. Consider that your long-term capital gains rate could increase from 15% to 20%. Therefore any long-term capital gains after December 31, 2012 when combined with the new Medicare tax could be taxed at 23.8%.
If you own assets with substantial gains you might consider selling these assets in 2012. If you believe the same assets have remaining appreciation potential, you can even consider buying them back and carrying them at a higher basis. These decisions are never simple and the right decision will depend on your individual circumstances.
For instance, if you have large capital loss carryovers, selling property to take advantage of the lower tax rates might not be right for you. If you expect to die soon, you might be better off waiting to transfer these assets (with substantial gains) to your heirs by inheritance allowing them to receive these assets with a stepped-up basis. This stepped up basis would reduce any gain the heirs might have when and if they sold these same assets. This thought might seem cold to some, but tax planning is about options and choices.
If you own a business, you're familiar with section 179 and the election to expense depreciable business property. It's been great, hasn't it? In 2010 and 2011 the tax code allowed you to deduct up to $500,000 worth of business property as long as your total property additions those years didn’t exceed $2 million.
This year the expensing limit has been reduced to $125,000 if total asset additions don’t exceed $500,000. In 2013, unless the Bush era tax cuts are extended, the section 179 limit will be $25,000 for businesses that place less than $200,000 of business property in service. Quite the drop. You really should be considering now whether it makes sense to accelerate any equipment purchasing decisions for business into 2012.
There is a laundry list of changes or potential changes in the tax laws in 2012 and 2013: increased individual income tax rates; expiration of the American Opportunity Tax Credit giving income tax breaks to students and their parents; more people exposed to the Alternative Minimum Tax; dividends no longer taxed at the long-term capital gains rates; expiration of the teacher's classroom expense deduction, etc., and etc.
You can worry, fret, or get angry about these changes in our income tax laws and do nothing, or you can work and plan to mitigate the damage through proper tax planning. Arranging your affairs to execute a tax plan that might mitigate any damage could take time.
You should start your tax planning now and not wait until Dec. 31.