Originally published in Anderson Kill & Olick, P.C.'s Estate Planning & Tax Advisor, Autumn 2012
Most financial planners consider the current tax environment to be one of historically low taxes. As Congress takes the Internal Revenue Code under consideration as a possible means of revenue generation, we expect income tax rates to increase and the current exemptions allowed for gift and estate taxes to be reduced. Each alteration would likely mean additional tax costs to taxpayers.
There is still time in 2012 to execute plans that will lessen your tax bite. Some of those plans are discussed below.
Accelerate Income/Defer Expenses
It is considered quite likely that federal income tax rates will increase in 2013, and so it would be wise to plan so that income will be taxed at a lower rate. Consider accelerating income into 2012 while deferring tax-deductible expenses to 2013. The net result will be that the combination of your income tax liabilities for both years, when compared to the same years with no planning, will be less.
If you are contemplating a large capital gain transaction, such as the sale of a home, business or securities, consider completing the sale before the end of 2012.
If possible, closely held corporations should consider distributing dividends before 2013, while they are taxed at only 15%.
Whether income tax rates increase or not, many of you will be subject to a new 3.8% Medicare surtax. Generally, if your total income exceeds $200,000 (single taxpayer) or $250,000 (married taxpayers, filing jointly), calculations will be required. The calculations will determine to what degree your investment income from taxable interest, dividends, annuity income, passive royalty income and rents will be subject to this additional 3.8% contribution to Medicare. The tax is new for 2013 and will catch many by surprise. Consider each income source to determine whether you have the ability to accelerate the income into 2012, thus avoiding the new tax for one year. If you are considering a Roth IRA conversion, why wait until 2013? Municipal bond interest is not subject to the 3.8% surtax, and so you may wish to alter some investments.
It is important to consider the ramifications of the above as they relate to alternative minimum tax (AMT). If your income exceeds $45,000 (for married taxpayers, filing jointly) and you have itemized deductions from real estate and state/local income taxes, you are likely to require an AMT calculation. Those tax deductions are considered tax preference items. When the result of income minus deductions is a tax lower than the AMT, the tax preference items lose their tax reduction effect and an additional minimum tax is levied. It is always wise when considering the ideas mentioned above that you contact your tax advisor and request that scenarios be computed so that the best tax scenario is chosen. As in past years, we await congressional relief from this AMT "stealth" tax, which may increase the exemption.
Estate and Gift Taxes
For tax year 2012 the federal annual gift-tax exclusion remains at $13,000. However, the lifetime exclusion for 2012 is $5.12 million. During 2012 you can bring your total lifetime gifting up to $5.12 million and all gifts will avoid federal gift tax. This may be your last opportunity to avoid gift taxes at such a high level. It is quite likely that this exclusion will be reduced during 2013 as Congress reviews our estate and gift taxes.
It remains unclear how estate taxes will change in the coming year. Please keep in touch with us so we can work with you to take advantage of what the law allows.
A note on the $13,000 annual exclusion: If you have donees who will be accessing a Section 529 qualified tuition plan, consideration should be given to a gift of $13,000 to that individual's 529 plan account. You may be able to make a tax-free contribution of as much as $65,000 in one year and treat it as having been made equally over the next five years. This would allow tax-free accumulation of all earnings and an increased ability to fund higher education expenses.
Out-of-Pocket Medical Expenses/ Flexible Spending Accounts
Medical expenses are currently deductible once the total exceeds 7.5% of your adjusted gross income. For many taxpayers this limitation will increase to 10% in 2013. If you expect material out-of-pocket medical expenses that can be moved into 2012 it would be tax-wise to do so.
There is a direct relationship between out-of-pocket medical expenses and flexible spending accounts (FSA). Medical expenses paid for with your pre-tax contribution to an FSA are not tax deductible. Beginning in 2013 the maximum allowable contribution to an FSA will be reduced to only $2,500. Presently, employers can set their own limits. This is not solely a tax consideration but one of cash flow as these expenses, formerly reimbursed through FSAs, will exceed the $2,500 contribution and increase your out-of-pocket expense.
Don't Forget Charitable Giving
Consider donating highly appreciated stock to charity. This allows the taxpayer to: 1) avoid capital gains tax on the increased value, 2) accomplish the taxpayer's charitable giving goals and 3) deduct the current value of the appreciated stock as a charitable donation. This idea might be more tax-effective in 2013 should the capital gains rate increase but should always be considered as a possibility.
Helpful Tip: The Internal Revenue Service continues to apply pressure on the reporting of foreign unearned income. As this pressure continues we strongly advise that you consider the ramifications of noncompliance. A U.S. taxpayer, whether a citizen or resident alien, must report worldwide income on his or her annual income tax return. The penalties for noncompliance are substantial. Full reporting of worldwide income, along with the annual filing of the Report of Foreign Bank and Financial Accounts (commonly known as FBAR), will avoid the penalties.
Phillip J. Benoit is a Certified Public Accountant who has extensive experience in tax return preparation and tax planning for individuals, and trust and estates. Mr. Benoit holds memberships in the American Institute of Certificated Public Accountants, the AICPA Tax Section and the National Association of Enrolled Agents (NAEA). He has been designated as a Fellow of the National Tax Practice Institution and has lectured nationally on issues of estate tax preparation and administration.
About Anderson Kill & Olick, P.C.
Anderson Kill practices law in the areas of Insurance Recovery, Commercial Litigation, Environmental Law, Estate, Trusts and Tax Services, Corporate and Securities, Antitrust, Bankruptcy, Real Estate and Construction, Anti-Counterfeiting, Employment and Labor Law, Captives, Intellectual Property, Corporate Tax, Health Reform and International Business. Recognized nationwide by Chambers USA for Client Service and Commercial Awareness, and best-known for its work in insurance recovery, the firm represents policyholders only in insurance coverage disputes – with no ties to insurance companies and has no conflicts of interest. Clients include Fortune 1000 companies, small and medium-sized businesses, governmental entities, and nonprofits as well as personal estates. Based in New York City, the firm also has offices in Ventura, CA, Stamford, CT, Washington, DC, Newark, NJ and Philadelphia, PA.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.