2012 Year End Tax Planning Letter

Yes, it is that time of year again. Our 2012 year-end tax planning letter is now available. This document is chock full of helpful information to help you take advantage of those last minute tax saving strategies and to help you avoid potential pitfalls. Click here to download/print the 2012 Year End Tax Planning Letter. Please call your JMF tax professional today to setup a year-end planning session. We are here to help.

The technical information in this letter is necessarily brief. No final conclusion on these topics should be drawn without further review and consultation. Please be advised that, based on current IRS rules and standards, the information contained herein is not intended to be used, nor can it be used for the avoidance of any penalty assessed by the IRS.

Dear JMF Clients and Friends,

Once tax filings are taken care of for the prior year, there is always the temptation to tuck current taxes away until the end of the year, when the tendency is to focus on tax strategies that can be executed quickly because of the short period of time remaining.

We would like to take a moment to focus on strategies that may take a little more time to implement but have the potential to reap significant tax savings.

Tax circumstances can change with a single event. Life events, such as marriage or divorce, the birth or death of a family member, retirement, relocation or a job change will generally alter your tax position, often drastically.

Conventional wisdom is to avoid paying taxes for as long as possible by accelerating deductions and/or deferring income. But conventional wisdom may not apply in 2012.

Without legislative changes, significant changes will be taking place in 2013, adding a higher level of uncertainty and reducing the value of traditional planning techniques.

The most broadly applicable change is the imminent expiration of the Bush-era tax cuts. The scheduled arrival of the new 0.9 percent tax on earned income and 3.8 percent tax on investment
income, enacted to pay for the 2010 healthcare legislation, also should not be overlooked.

We are here to help you navigate what is known thus far and help you plan for both the remainder of 2012 and the years to come.

Planning in Times of Tax Rate Change

Basic framework

Intentionally raising taxable income in the current year is contrary to the long-standing general guidelines to tax planning. Historically, tax planning has focused on accelerating deductions into the current year and deferring income into future years. But, with rates scheduled to increase, what has worked in years past may not produce the best tax outcome for the future.

The basic framework to help shape your overall income tax planning in 2012 is as follows:

If you expect to be in a higher income tax bracket in 2013, consider accelerating income into 2012 and deferring deductions to 2013.
If you are forecasting a lower income tax rate in 2013, reverse the strategy: Consider deferring income and accelerating deductions.

This year and going forward, keep in mind that focus should always be on your marginal tax rate the highest rate at which your last, or marginal, dollar of income will be taxed. Even though overall tax rates may rise in the future, if your income will be substantially lower in 2013 than in 2012, your marginal tax rate may decrease under the graduated tax bracket system. The marginal tax rate chart for 2012 is posted on our website here.

It’s also important to keep in mind a couple of additional key income tax concepts while mapping out tax techniques for 2012:

Alternative Minimum Tax – In years that you are subject to the alternative minimum tax (AMT), your deductions may be limited. If you anticipate being subject to AMT in either 2012 or 2013, consider
timing those deductible expenditures that are limited under the AMT regime to maximize deductibility.

Standard Deduction – If you expect to claim the standard deduction in either 2012 or 2013, shift itemized deductions into the year in which you will not claim the standard deduction to take full
advantage of the deductions.

Rising tax rates
Individual income tax rates are set to rise on Jan. 1 of next year to a top rate of 39.6 percent – a 13 percent increase over the highest rate in recent years. In addition, limitations on both itemized
deductions and personal/dependency exemptions are scheduled to return for 2013, potentially raising the income tax rate another 3 to 4 percentage points for taxpayers subject to these limitations.

Further still, dividends are set to once again be taxed as ordinary income in 2013. The 15 percent rate enjoyed on qualified dividends for a number of years could potentially become a 39.6
percent rate. The top tax rate on long-term capital gains is also set to increase by roughly one third to 20 percent.

See chart on the PDF for ordinary income rates, long term capital gains, and qualified dividends.

Unfortunately, the increasing rate news does not end here. The tax impact of the 2010 healthcare legislation begins in 2013 with two new Medicare taxes, the Medicare earned income surtax and the net investment income Medicare tax.

Taxpayers with modified adjusted gross income above $200,000 ($250,000 on a joint return) will be subject to these additional taxes:

Medicare Earned Income Surtax – An additional 0.9 percent Medicare tax will apply to earned income, such as wages.
Net Investment Income Medicare Tax – A 3.8 percent net investment income Medicare tax will apply to the lesser of net investment income, including interest, dividends and capital gains or the
excess of adjusted gross income over the limits listed above.

For taxpayers above the threshold, the impact of these two new taxes will be broad-reaching. With the addition of the net investment income Medicare tax, the top rate for long-term capital
gains will rise by more than 50 percent to 23.8 percent, while the top ordinary income rate for those with dividend income will rise by more than 185 percent to 43 percent.

Planning now may reduce the tax burden in years to come, and the timing and composition of earnings become critical. Potentially, a bonus from your company during 2012 instead of 2013 or a 2013 capital transaction accelerated into 2012 could save significant tax dollars. With the uncertainty in future tax rates due to the upcoming elections, now may not be the best time to initiate the transaction. But, it is a good time to plan those transactions so that they can be made before year end if changes are not made to 2013 tax rates after the elections.

Neither of the new Medicare taxes apply to retirement plan distributions, IRA payouts or tax-exempt income, such as interest from state and local government bonds.

Increases in tax rates are generally adverse for most taxpayers, but with increased rates comes increased value in your deductions, making this a great year to strategize with your tax adviser about the best timing for your deductions.

Here are some 2012 and 2013 planning points to consider when or if the new Medicare taxes go into effect Jan. 1, 2013:

Mind the income threshold – If you expect your 2013 modified adjusted gross income (AGI) will be close to, or just above, the $200,000 (single filer) or $250,000 (joint filers) threshold, you may be able to avoid both of the new Medicare taxes by accelerating income into 2012. Keep in mind that the new net investment income Medicare tax applies only to taxpayers who have both net investment income and AGI above the threshold amounts.

Reconsider investment interest expense deductions – If you have an investment interest expense carryover into 2012, consider not electing to tax qualified dividends or long-term capital gains at ordinary rates to maximize the investment interest expense deduction. Since qualified dividends revert to ordinary income in 2013, by not electing to tax 2012 qualified dividends and long-term capital gains at ordinary rates you will preserve investment interest expense deductions that can be used in 2013 and later years to offset income that may be taxed at higher ordinary income tax rates as well as reduce the exposure to the new net investment income Medicare tax. This technique can be decided when you file your 2012 tax returns in 2013.

Spread the gain – Installment reporting spreads the investment income from the gain on a sale over a period of years, reducing AGI and deferring recognition of the investment income. However, electing out of installment
reporting in 2012 results in gain recognition before the higher tax rates go into effect.

Transfer investments to family members – Although your children’s investment income may be taxed at your marginal tax rate under the “kiddie tax” rules, an unmarried child is subject to the net investment income Medicare tax only if the child’s AGI exceeds $200,000. You may be able to use a family limited partnership or other techniques to spread some of your investment income among your children and avoid the 2013 net investment Medicare tax on that income.

Planning Your Estate and Gifts

Absent congressional action, the $5.12 million estate tax exemption and current top tax rate of 35 percent, in place for 2012, will revert to a $1 million exemption with a top tax rate of 55 percent beginning Jan. 1, 2013. Moreover, the estate tax exemption will no longer be portable between spouses.

With the lifetime gift exclusion also at $5.12 million for the remainder of 2012, there exists what could be an once-in-a-lifetime opportunity to transfer significant assets to the younger generation without incurring any wealth transfer taxes. On Jan. 1, 2013, the lifetime gift tax exclusion is scheduled to revert to $1 million.

Along with the high gift tax exemption, the generation-skipping transfer tax exemption is also $5.12 million during 2012. So the door is open to bypass children and defer the impact of estate taxes for many years into the future.

It’s uncertain where the estate tax exemption and tax rates will end up in future years. And with the expiring provisions, it’s a good idea to review your plan to ensure it is up to date.

Legislation proposed in Congress to limit valuation discounts attributable to minority interests or lack of marketability could also potentially affects wealth transfer. The tax cost of gifts could
increase should the changes be enacted.

Since these rules have not yet gone into effect, planning potential remains. Before transferring interests in family businesses or family limited partnerships, consult with your tax adviser to
discuss potential tax and valuation pitfalls.

The gift tax annual exclusion remains at $13,000 per donee, or recipient, for 2012. With giftsplitting, spouses can transfer up to $26,000 to each person before the lifetime gift tax exclusion
comes into play.

Gifting techniques you may want to consider this year include:

Outright gifts to family members
Transfers to family members through a family limited partnership or family LLC
Transfers in trust, including:

Irrevocable life insurance trusts
Defective grantor trusts
Charitable trusts

Other Tax Planning Opportunities

Timing of payments

Reviewing your withholding and planned quarterly estimated tax payments now provides the flexibility to adjust payments to limit or prevent penalties and manage cash flow.

Underpaying your taxes over the course of the year will subject you to underpayment penalties, which can be reduced or eliminated by increasing your withholding or quarterly estimated tax payments. A quirk in the penalty rules treats withholding, even if it occurs late in the year, as if it had been taken evenly throughout the year, making it a powerful planning tool for individuals.

On the flip side, why remit payment too soon when you can invest those funds until April 15, 2013? If your 2012 income or expenses have changed significantly since your tax estimates were prepared, it would probably be a good idea to review those changes with us before the end of the year to determine their impact on your income tax estimate payments.

Retirement funding

You can reduce your current tax obligations and help save for your retirement in a tax-efficient manner by contributing to a tax-qualified retirement plan. Qualified plans provide tax deferral on earnings until you receive distributions or tax avoidance in the case of Roth accounts.

The earlier you make the contribution, the sooner your tax-deferred or tax-free earnings begin. If you already have a retirement plan in place, consider funding it as soon as possible to allow
funds to start growing now.

To qualify for a tax deduction in 2012, your retirement plan generally must be in place before the end of the year. Exceptions are IRAs and SEPs (simplified employee pension). IRAs can be set up and funded through April 15, 2013 while SEPs can be set up and funded through the extended due date of the return.

Establishing a new retirement plan requires thoughtful decision-making. Small employers (generally those with 100 or fewer employees) that set up a qualified retirement plan may be eligible for a tax credit of up to $500 per year for three years. The credit is limited to 50 percent of the qualified startup costs.

The following contribution limits, along with the catch-up contribution limits for those 50 and older, apply for the 2012 tax year:

See chart on the PDF for contribution limits for 401(k), IRA, simple IRAs, and self employed.

Individuals with earned income, including alimony, are generally eligible to contribute to traditional IRAs. Claiming a deduction for your contribution is another matter. It depends on your income and whether you or your spouse is covered by an employer-sponsored retirement plan.

If neither you nor your spouse is covered by an employer’s plan, you may deduct your contribution to your traditional IRA. If you or your spouse is an active participant in an employer-sponsored plan, the deduction for your IRA is phased out at the following adjusted gross income (AGI) levels:

See chart on the PDF for AGI phase-put levels.

Many taxpayers find the long-term benefits of contributing to a Roth IRA or a Roth 401(k) outweigh the short-term financial benefits of tax-deductible contributions. While Roth contributions are not tax-deductible, none of the income earned in the Roth account will have tax consequences unless there are early distributions, in which case penalties may apply. In addition, the Roth account is not subject to the required minimum distribution rules that apply when you reach age 70½.

Eligibility to contribute to a Roth IRA depends on the amount of your income level. Contributions are fully allowed if your modified adjusted gross income for 2012 is less than $110,000 for singles and $173,000 for joint filers. The eligibility to contribute a Roth IRA phases out for singles with modified adjusted gross income between $110,000 and $125,000 and for joint filers with modified adjusted gross income between $173,000 and $183,000. Eligibility to contribute to a Roth IRA depends on the amount of your income. If you are not eligible because your income is too high, you may want to consider a nondeductible IRA that can be converted to
a Roth IRA in 2012 or later.

You can still roll your retirement savings from your traditional IRA or other qualified retirement plan into a Roth IRA. However, you must pay tax on the rollover amount. Unlike in past years,
income limits no longer apply to Roth rollovers.

You might want to consider a Roth rollover in 2012 if you expect to be subject to the unearned income Medicare contribution tax in future years. Although distributions from a traditional IRA are not subject to the net investment income Medicare tax, taxable IRA distributions increase your modified adjusted gross income. If your AGI exceeds the $200,000/$250,000 threshold, your investment income will be subject to the net investment income Medicare tax.

By rolling over your traditional IRA to a Roth IRA in 2012, you will recognize the additional income before the net investment income Medicare tax goes into effect. Once you have had a Roth IRA account in place for five years, future distributions from the Roth IRA will be nontaxable and will not increase your modified adjusted gross income.

If you own a business, you may qualify to adopt a defined benefit type of retirement plan. These plans often allow higher retirement contributions than other types of plans. The higher retirement benefit must be weighed against the additional cost of providing comparable retirement benefits for your employees.

Employee related benefits

Federal Health Insurance Credit

If you are not currently providing health coverage for your employees, a tax credit for small businesses may make the cost of purchasing this coverage more affordable. The maximum credit is 35 percent of the premiums paid by the employer. To be eligible for the credit, the employer generally must contribute at least 50 percent of the total premium. The full credit is available for employers with 10 or fewer full-time equivalent employees (FTEs) and average annual wages of less than $25,000. Partial credits are available on a sliding scale to businesses with fewer than 25 FTEs and average annual wages of less than $50,000.

Alabama Reemployment Act

Employers hiring new employees during 2010 or 2011 who were unemployed and who had drawn unemployment benefits may take a deduction for up to 50% of the gross wages paid to the previously unemployed person. The employee must be employed for 12 months before the deduction can be claimed. Only wages paid to employees earning at least $10 per hour qualify for the additional deduction. The extra deduction is equal to 50% of the wages paid to qualifying employees paid $14 or more per hour. The extra deduction drops to 40% of wages paid to qualifying employees who earned between $12 and $14 per hour and 35% of wages paid to qualifying employees who were paid between $10 and $12 per hour. Consequently, employers may deduct up to 150% of the wages paid to qualifying employees on their 2011 and 2012 Alabama returns.

Alabama 100% Health Insurance Premium Deduction

For tax years beginning after December 31, 2010, in addition to any other Alabama income tax deduction that a qualifying employee may be entitled to with respect to the payment of health insurance premiums, qualifying employees are allowed to deduct from Alabama gross income 100 percent of the amounts they pay as health insurance premiums as part of an employer provided health insurance plan provided by a qualifying employer. In addition to any other Alabama income tax deduction that a qualifying employer may be entitled to with respect to the payment of health insurance premiums paid on behalf of qualifying employees, the qualifying employer is also allowed as a deduction in the computation of Alabama taxable income 100 percent of the amounts they pay as health insurance premiums on behalf of qualifying employees in connection with an employer provided health insurance plan.

New employees

Congress extended the Work Opportunity Tax Credit for employers that hire eligible unemployed veterans after Nov. 22, 2011, and before Jan. 1, 2013. The credit can be as high as $9,600 per veteran for for-profit employers or up to $6,240 for tax-exempt organizations.

The amount of the credit depends on a number of factors, including the length of the veteran’s unemployment before hire, hours a veteran works and the amount of first-year wages paid. Employers who hire veterans with service-related disabilities may be eligible for the maximum credit.

If you own a business and have children, consider putting them to work during summer vacation or after school. You will be able to deduct their wages as long as you make their pay commensurate with what you would pay a nonfamily employee for the same services. For 2012, they can earn as much as $5,950 and pay zero income tax. You may also want to consider contributing $5,000, or their wages if smaller, to a Roth IRA for the child.

Capital expensing

Generous expensing rules apply to most non-real estate assets acquired and placed in service during 2012. The expensing election limit under Section 179 is set at $139,000 if the total amount of qualified asset purchases does not exceed $560,000. The deduction is available for most business equipment, furniture and off-the-shelf computer software.

There are limits to the Section 179 deduction, including a requirement that the deduction not cause or increase a taxable loss. But the 50 percent bonus depreciation election, also available through the end of 2012 for new assets, is available even if you have a taxable loss.

The key to qualifying for these enhanced deductions is that the asset must be placed in service by Dec. 31, 2012. Just ordering or paying for the asset is not enough. Considering the time it may take to identify the appropriate equipment, obtain competitive bids, order the product, have it assembled and shipped, and then get it installed and operational, now may be the time to begin the acquisition process.

With tax rates on personal income scheduled to rise in 2013, those who operate businesses as S corporations, partnerships, LLCs and sole proprietorships will have to consider carefully whether to take advantage of the enhanced business deductions available for assets placed in service during 2012. Particularly for assets with shorter depreciable lives, forgoing the enhanced deductions for 2012 may result in more tax savings in 2013 and later years. The decision as to whether to claim Section 179 expensing or bonus depreciation can be made in 2013 when your tax return is prepared.

In Summary

No one can predict the future, and predicting future actions of Congress is particularly hazardous. Congress can – and all too often does – change the tax law at a moment’s notice. The November elections will obviously have a significant impact on the planning process for 2012 and future years.

Tax planning is an ongoing process. Saving taxes is generally a good strategy, but making a bad business, investment or personal decision just to save some tax dollars is never a good strategy.

We have covered a number of topics here, but we undoubtedly did not address every issue relating to your specific situation. Please let us know if we can help guide you through your 2012
tax planning and the complex maze that is our U.S. tax system.

Sincerely yours,

JAMISONMONEYFARMER PC
Certified Public Accountants
2200 Jack Warner Parkway, Suite 300
Tuscaloosa, Alabama 35401
205.345.8440 | info@jmf.com | www.stg-zofavina-staging.kinsta.cloud

2012 Year End Tax Planning Letter