Grant Thornton is offer some year-end tax planning tips for both individuals and businesses, and their accountants, facing the expiration of the Bush tax cuts.
The Bush-era tax cuts enacted in 2001 and 2003 are scheduled to expire in 2013, the firm noted, and new Medicare taxes are scheduled to take effect. Without congressional action, tax rates will rise to as high as 39.6 percent on ordinary income and 23.8 percent on capital gains.
“Taxpayers should be paying special attention to their year-end tax planning in 2012,” said Mel Schwarz, a partner in Grant Thornton’s Washington National Tax Office, in a statement. “This year, flexibility is the name of the game. Until Congress acts, both businesses and individuals are facing a slew of tax increases in 2013 that will turn traditional tax planning on its head. This year, successful tax planning means preparing to react to the last minute success or failure of Congress to avoid these tax increases.”
Many businesses and individuals are wondering whether this is the year to reverse their tax strategy and accelerate income and defer deductions so they can pay tax before rates go up.
Other changes in the tax law must also be considered in preparing for 2013.
Here are some of the most important 2012 tax planning considerations for businesses:
1. Understand new reporting requirements. This year, for the first time, employers will be required to provide the IRS and employees with the total cost of 2012 group health coverage. This information must be reported on the Form W-2, which is used to report employee wages and withholding and is due Jan. 31, 2013.
2. Consider the timing of business investments. The rules for deducting investments in your business have changed. Last year, 100 percent bonus depreciation allowed businesses to fully deduct the cost of eligible equipment placed in service. Property placed in service in 2012 is only eligible for 50 percent bonus depreciation—meaning you can deduct half the cost of eligible equipment placed in service this year, while the other half will be depreciated using normal rules. Property placed in service in 2013 is will not be eligible for bonus depreciation at all. To qualify for bonus depreciation, the property you place in service must be new and generally have a useful life of 20 years or less under the modified accelerated cost recovery system, or MACRS.
3. Consider ‘S’ corporation status. Even if individual tax rates increase, the single level of taxation available for S corporations is such a significant benefit that any privately held company should at least consider the advantages of converting or organizing as such. A conversion is made with a simple election for tax purposes and doesn’t affect the liability protection of a corporation. But there are many things to consider first. You must satisfy many requirements to qualify for S corporation status, including number of shareholders.
4. Prepare for possible tax increases in 2013. If Congress does not act to prevent it, the new Medicare tax and the scheduled expiration of the 2001 and 2003 tax cuts will raise tax rates for individuals on many types of income. Pass-through businesses whose profits are taxed at the individual level may want to consider reversing normal tax strategy and accelerating income into 2012 and deferring deductions into 2013 to avoid the rate increases. There are strategies for deferring deductions and recognizing income, but the key is to be flexible. It may not make sense to accelerate tax. We don’t know what will happen legislatively yet. You want to prepare your strategies but delay executing them until the situation in Congress becomes clearer.
5. Help employees prepare for possible tax increases. Corporate employers can help their employees prepare for possible tax increases by facilitating flexibility with respect to the payment of bonuses and deferred compensation. For example, many accrual basis corporations declare bonuses before year end but pay them shortly after the new year. The corporation deducts the bonus in the year paid, but the employee does not have to include the bonus in income until the year it is paid. If it appears Congress will not act and rates will increase in 2013, it may benefit the employee to pay the bonus at the end of December, allowing it to be taxed under the current rates. But, make sure this will not force the employee into a higher bracket, and do not give the employee the option of when to receive the bonus. The IRS will treat this as constructive receipt and require the employee to include the bonus in 2012 income, whether the option is accepted or not.
Here are some of the most important 2012 tax planning considerations for individuals:
1. Give a lifetime supply of gifts. With transfer taxes at historic lows and ideal economic conditions, now is a great time to think about transferring assets. The $5.12 million gift tax exemption and the 35 percent rate are the most favorable in decades, and they aren’t scheduled to last. Without congressional action, the top estate and gift tax rate will be 55 percent in 2013 with an exemption of $1 million. Now is the time to act, especially while historically low interest rates enhance many of the best gifting strategies.
2. Make up a tax shortfall with increased withholding. Don’t forget that taxes are due throughout the year. Check your withholding and estimated tax payments now while you have time to fix a problem. If you’re in danger of an underpayment penalty, try to make up the shortfall through increased withholding on your salary or bonuses. A bigger estimated tax payment can still leave you exposed to penalties for previous quarters, while withholding is considered to have been paid ratably throughout the year. To avoid any penalties, the best action plan is to make sure you pay estimated taxes equal to 110 percent of your estimated tax liability.
3. Consider flipping your tax strategy to avoid tax increase. You generally want to accelerate deductions and defer income—why pay tax today when you can put it off until tomorrow? But if tax rates increase next year, it may be wise to reverse this strategy. Paying tax now at a lower rate may save you taxes in the long run. There are plenty of income items and expenses you may be able to control. Consider accelerating bonuses, consulting income or self-employment income. On the deduction side, you may be able to defer state and local income taxes, interest payments and real estate taxes. But be careful, because there are many things that could make tax acceleration a bad idea, including the alternative minimum tax, estate and gift tax implications, legislation, and even the time value of money. Also, stay flexible. If rates do not increase traditional tax strategies will still be best.
4. Consider selling assets. If your capital gains rate will increase in 2013, you can consider selling assets now to take advantage of today’s low rates. Stock and other securities can be sold and bought back immediately allowing the payment of tax without changing position. This gives you an increased basis in the asset for future sale but it may make more sense to take advantage of today’s low rates to diversify a concentrated position. If much of your portfolio is tied up in one stock or asset because you’re deferring the tax bill on a large gain, keep in mind that rates only have one way to go from here. But be careful because the time value of money still often makes deferral a better strategy and there are many other factors to consider, including whether your tax rate actually increases.
5. Leverage retirement account tax savings. It’s not too late to maximize contributions to a retirement account. Traditional retirement accounts like 401(k)s and IRAs still offer some of the best tax savings in the tax code. Contributions reduce taxable income at the time you make them, and you don’t pay taxes until you take the money out at retirement. The 2012 contribution limits are $17,000 for a 401(k) and $5,000 for an IRA (not including catch-up contributions for those 50 and older). Remember that 2012 contributions to your IRA can be made as late as April 15, 2013.
