Tax Planning With Uncertain Tax Rates web image

As we look ahead to 2013, we again face uncertainty on income tax rates. But there are some strategies to consider now, particularly if you have transactions that could be placed either into 2012 or 2013.

Tax Planning With Uncertain Tax Rates

  • 3/20/2012

Tax Planning With Uncertain Tax Rates

As we look ahead to 2013, we again face uncertainty on income tax rates. The present six-tiered rates (ranging from 10-35 percent), and the favorable two-tiered capital gain and dividend rates (0-15 percent), all expire at the end of 2012.

If Congress takes no action, we revert to the old rates (15-40 percent), a capital gain rate of 20 percent, and dividends taxed at ordinary rates, all beginning in 2013. The Obama administration has stated its desire to increase upper-tier income tax rates and the dividend and capital gain rates for higher-income taxpayers. So how should that possibility enter into your tax planning for 2012 and after?

“We aren’t going to know much until after the November 6 election,” points out Bob Gibson, a private client tax partner with CliftonLarsonAllen. “But there are some strategies to consider now, particularly if you have transactions that could be placed either into 2012 or 2013.”

The scheduled 2013 tax rates

In this election year, the discussion on tax rate increases has moved into the political arena, and it can be hard to separate reality from political posturing. The federal tax law currently has two rate increases coming in 2013, one from recent legislation, and the other from expiring legislation:

  • Income surtaxes from the Patient Protection and Affordable Care Act 
    Last month, we communicated about the new 3.8 percent tax on net investment income and the 0.9 percent Medicare tax on earned income (Plan for High Income Surtaxes in 2013). Those increases begin in 2013, unless a future Congress and new President would agree to reverse these taxes.
  • Expiration of the 2001 tax cuts 
    The second scheduled tax increase is the return of old tax brackets and rates from before 2001. This would increase taxes for most filers, as the lower tier rates would increase as well as the upper tiers. Lower rates, increased credits, and other temporary changes made in 2001 and 2003 are referred to as the “Bush tax cuts,” and their expiration at the end of 2012 would raise taxes across the board.

“We’ve been to the edge of the cliff before on the expiration of those old tax cuts,” says Chris Hesse, a tax partner with CliftonLarsonAllen. “At the end of 2010, Congress and the President faced this same issue, and agreed to extend those cuts through 2012.”

The difference this time regarding the expiration of those tax cuts, of course, is the upcoming November 6 election. We don’t expect any answers on this until after that election, and more likely not until the new Congress is seated in 2013. “Regardless of the election outcome, it is very unlikely that Congress will do nothing and let all of the old rates come back into place,” notes Hesse. “That would cause a rate increase on all taxpayers from top to bottom, and no one seems to want that to happen.”

As a result, Hesse says taxpayers with pending income-recognition transactions are adrift in a sea of uncertainty. But there are some strategies to consider now.

Tax planning strategies

Gain harvesting 

Those with appreciated stock and other capital gain securities may want to consider “gain harvesting” in 2012. For upper income returns, there is the reality of the 3.8 percent investment income tax coming in 2013, and the threat of an increased capital gain rate. “If the November election results indicate higher rates are on the way, security gains can easily be captured before December 31,” says Gibson. “And there is no restriction against reinvesting, as there is when a taxpayer sells at a loss and attempts to repurchase that same security.”

Exercising stock 

Employees holding non-qualified stock options that can be exercised in 2012 or 2013 will also face a similar quandary. Exercises made in 2012 accelerate the compensation, but also are certain to avoid the 0.9 percent new Medicare tax in 2013 and the possibility of higher ordinary rates.

Business or land sale 

For those with a once-in-a-lifetime business or land sale in the works, facing a major capital gain in this time of uncertainty is also problematic. If all else is equal and a sale could be closed in either late 2012 or early 2013, taking the “bird in hand” at today’s favorable 15 percent capital gain rate would seem to be an obvious choice. And if the seller is going to get paid over a number of years in an installment sale transaction, it could also make sense to push for a closing within 2012.

If the sale is within 2012, a taxpayer can elect to opt out of deferred tax reporting on their return, in order to tax the gain entirely in 2012. “This election does not need to be made until the extended due date of the 2012 tax return, which can be in the fall of 2013. By then, the tax rate issue will have more clarity,” says Hesse. If this strategy is being considered, it’s important to collect a large down payment in 2012, or perhaps a second payment in early 2013, so as to have sufficient cash to pay all the tax if the decision is made to accelerate the entire gain.

Stay tuned

“A key point,” says Gibson, “is to recognize that higher rates are not a foregone conclusion, other than the 3.8 percent investment income tax and 0.9 percent Medicare tax on earned income.” While the political rhetoric will be high-pitched in the months ahead, it is important not to overreact. Our firm is closely monitoring tax developments and legislative action in Washington. We will continue to keep a close eye on the tax rate situation, and issue advisories as the picture comes into focus.

How we can help

Consult with your CliftonLarsonAllen tax advisor if you have gains or other major transactions that could affect your tax return. Remember, it is not only the rate system, but the particular deductions unique to your tax return that can influence the selection of the best year for major tax recognition transactions.

Bob Gibson, Private Client Tax Partner or 630-368-3602

Chris Hesse, Tax Partner or 612-376-4760