United States: Planning For Potential Tax Increases In 2013

Large tax increases are scheduled to take effect in 2013 unless Congress acts — making tax planning more important than ever. The decisions your business makes now may have a tremendous impact on your tax obligations in the future. Unfortunately, tax planning is also more difficult than ever. The November election and political gridlock have made the outlook for legislation uncertain.

The tax increases are scheduled to come primarily from the individual side of the tax code, with new Medicare taxes and the expiration of the 2001 and 2003 tax cuts. Partners and shareholders in pass-through businesses will be affected directly, and the tax increases will also affect executives and owners of other privately held businesses and even public companies.

Many businesses have begun considering whether 2012 is the year to reverse tax strategy and accelerate income and defer deductions. This should be approached very cautiously. First, you need to understand exactly which taxes are scheduled to increase and by how much, and how those increases would actually affect your business, its owners and its employees. You also need to understand the likelihood that these tax increases will actually occur. That's why it is prudent to prepare now but wait to act until the legislative outlook becomes clearer. This Tax Insights will help by:

  • explaining exactly which taxes are scheduled to increase and the outlook for legislation to prevent it,
  • discussing the factors you need to consider when deciding whether to defer or accelerate tax, and
  • discussing the specific tax issues and planning ideas that need to be addressed.

What's really coming?

Tax increases under current law

Both payroll and income taxes are scheduled to increase starting on Jan. 1, 2013 (see Tax Insights 2012-09 for a discussion of estate and gift taxes). Without legislative action, the 2001 and 2003 tax cuts will expire and new Medicare taxes enacted as part of the health care reform legislation in 2010 will take effect. The expiration of the 2001 and 2003 tax cuts would erase scores of benefits, including:

  • rate cuts across all income brackets,
  • the full repeal of the personal exemption phaseout (PEP) and "Pease" phaseout of itemized deductions,
  • the top rate of 15% for capital gains and dividends,
  • the zero rate for capital gains and dividends in the bottom brackets,
  • marriage penalty relief,
  • the $1,000 refundable child tax credit and increased dependent care credit,
  • the $12,650 adoption credit and $12,650 exclusion for employer adoption assistance,
  • the employer credit for child care facilities, and
  • several education-related incentives.

The loss of rate cuts is the most significant threat. The top ordinary income tax rate would increase from 35% to 39.6%, the top capital gains rate would increase from 15% to 20% (property held more than five years would be eligible for an 18% rate), and dividends would be taxed at ordinary income levels up to the top rate of 39.6%, up from 15%.

These tax increases will be compounded by additional Medicare taxes. First, the rate of the individual share of Medicare tax will increase from 1.45% to 2.35% on earned income above $200,000 for single and $250,000 for joint filers. The 1.45% employer share will not change, creating a top rate of 3.8% on self-employment income. In addition, investment income such as capital gains, dividends and interest will be subject for the first time to a new 3.8% Medicare tax to the extent AGI exceeds $200,000 (single) or $250,000 (joint).

The new tax on investment income will not apply to distributions from qualified retirement plans or active trade or business income. Active S corporation income not paid as salary will still not incur Medicare tax, as it is not earned income.

A two year partial payroll tax holiday, which cut the individual share of Social Security tax from 6.2 percent to 4.2 percent, is also scheduled to expire at the end of the year, but Social Security taxes are already capped annually ($110,100 in 2012).

The combined tax increases would severely affect top rates on all types of income. The top rates on dividends, interest and earned income would apply when income reached the top tax bracket ($388,350 in 2012), though the Medicare portion would apply at the $200,000 or $250,000 thresholds. The top rate of 23.8% on capital gains would be reached at the $200,000 or $250,000 thresholds.

Potential for legislation

Congress has so far made little progress. Both parties held votes on separate plans to extend the 2001 and 2003 tax cuts before adjourning for the August recess, but these votes were largely vehicles to stake out campaign positions. No legislation is expected until after the elections, when lawmakers are likely to return in November to work on a lame duck compromise. In a similar process in 2010, the president agreed to extend the 2001 and 2003 tax cuts for two years, but an agreement may be more difficult this year.

The bills voted on by Democrats and Republicans would both extend the tax cuts for one year, except the Democratic bill would allow the tax cuts to expire for income above certain thresholds ($200,000 minus the standard deduction and a personal exemption for singles and $250,000 minus the standard deduction and two personal exemptions for joint filers). Capital gains and dividends above these thresholds would be subject to a top rate of 20%, and PEP and Pease would be reinstated with phase-ins beginning at these thresholds.

Despite the political nature of the votes, they do offer insight into the outlook for eventual legislation. For one, lawmakers appear to have settled on an extension for just one year. A one-year extension is meant to give lawmakers time and leverage for a potential tax reform effort in 2013.

The votes also reveal that congressional Democrats are committed to campaigning on a promise to roll back the tax cuts above the $200,000 and $250,000 thresholds, although there may be room for negotiation in a lame duck session. Several Democratic lawmakers had previously floated the idea of extending the 2001 and 2003 tax cuts on income up to $1 million.

It may be significant that Republicans did not attempt to repeal the new Medicare taxes in their bill to extend the 2001 and 2003 tax cuts. Even though Republicans have already voted to repeal the Medicare tax in separate legislation, the failure to link repeal of the Medicare tax with an extension of the 2001 and 2003 tax cuts may make it more difficult to address the Medicare tax in a lame duck compromise on the other expiring tax cuts.

It is difficult to predict a final outcome. The results of the election will have an impact, but a bipartisan compromise will still be needed. If President Obama is re-elected, he will need to negotiate with Republicans in Congress. If Republicans take both chambers and the White House, they will still need to negotiate with Democrats in the Senate to overcome procedural hurdles. President Obama agreed to an extension of all the tax cuts in 2010, but he is now facing a more dire debt situation and has been more rigid in his calls for additional revenue. The extension of most of the 2001 and 2003 tax cuts remains likely, but the outcome for the tax cuts at high income levels is uncertain. The repeal of the Medicare tax may be an uphill battle given the current condition of the Medicare trust fund and the political sensitivity of the issue.

Considerations for determining whether to accelerate or defer

With the clear potential for tax increases, taxpayers may be tempted to accelerate tax into 2012 by deferring deductions and recognizing income. But a careful analysis of several factors should come first, and there are many reasons why accelerating tax is a bad idea.

First, determine whether the tax increases will apply to your business. No tax increases are scheduled at the entity level — they will instead affect the income of your business's owners and executives at the individual level. Tax increases are also unlikely to affect any income below the income thresholds of $200,000 (single) or $250,000 (joint). And it's possible taxes won't increase at all. Accelerating tax in 2010 provided little or no benefit when the tax cuts were eventually extended. That's why it will be prudent to prepare now but act only when the legislative outlook becomes clearer.

Because the tax increases will apply at the individual level, it will be important to understand the tax situations of individual shareholders and partners. Taxpayers subject to the alternative minimum tax may not benefit from any acceleration in tax. In addition, when comparing current and future tax rates, it is important to remember that many taxpayers will be in a lower tax bracket at retirement. Finally, taxpayers with significant estates need to consider transfer tax consequences. Triggering gain can backfire if an asset otherwise would have received a step-up in basis at death.

You also need to consider the actual rate change versus the time value of money. The tax increases would affect many types of income in different ways. When thinking about accelerating tax, it is important to understand exactly how much tax would be paid in the future and how long you otherwise could have deferred this tax. Even at today's low interest rates, the time value of money will still make deferral the best strategy in many situations. You probably do not want to trigger gain on property you would otherwise have held onto for years just to avoid a capital gain rate increase from 15% to 20%. Economic considerations should always come before any tax-motivated sale.

Specific issues and planning ideas that need to be considered

Once you understand how the tax increases would affect the business, there are several specific issues and planning opportunities to consider before the end of the year. Even if it appears unwise to accelerate tax, you want to carefully evaluate your typical year-end decisions. Your business controls the timing of many income and deduction items for both owners and employees. Regardless of your strategy, it's important to recognize how these decisions will affect the timing of tax.


Businesses may have competing interests with employees. High-income employees may want to recognize income before tax increases take effect, while the owners of the business that employs them may want to save compensation deductions for the following year.

Year-end bonuses will be important. Frequently, accrual method employers will declare bonuses before the end of the year and then pay them during the first 2˝ months of the following year. This allows the employer to deduct the bonuses in the year they are earned, while allowing the employee to defer including the bonus in income until the following year. Either side of this strategy can be reversed. If a deduction will be more meaningful in 2013 for the owners of a business, accrual method taxpayers may consider purposely postponing when they will satisfy the "all events" test in Section 461, which determines when a liability is taken into account. Accrual method taxpayers can also postpone the deduction to 2013 by paying the bonus more than 2˝ months after the end of the year. Alternatively, employees concerned about increased tax rates may benefit if the bonus is both declared and paid in 2012.

Employers seeking to offer employees a chance to avoid tax increases should be careful not to give employees a choice on the timing of bonuses and other pay because this will likely cause taxation on the first date the compensation is available under the constructive receipt doctrine, regardless of the employee's choice.

Employers can also consider accelerating the vesting dates of restricted stock grants and nonqualified deferred compensation (NQDC). Employees recognize income from restricted stock on the vesting date and Medicare taxes are due on NQDC at the time of vesting. In addition, employers can point out several individual tax acceleration strategies to employees, including:

  • Exercising NSOs— The spread between the exercise price and the fair market value of nonqualified stock options (NSOs) is ordinary income when exercised. Exercising them early also starts the holding period for long-term capital gain treatment.
  • Exercising ISOs— Taxpayers who will not hold incentive stock options (ISOs) long enough to qualify for capital gain treatment can exercise them and sell them before rates increase.
  • Converting to a Roth account—Tax is due on the amount converted in the year of a conversion from a traditional IRA to a Roth IRA in exchange for no tax on future distributions.
  • Accelerating Medicare taxes on NQDC— Payroll taxes (including Medicare taxes) are generally due on defined benefit NQDC plans upon vesting. Employers are allowed to postpone the payment of these payroll taxes when the value of the future benefit payments cannot be ascertained. Employers could reverse this approach in 2012 and pay payroll taxes on accrued benefits by using assumptions to calculate an estimate of the value of future benefit payments. Employees with earned income above $200,000 (single filers) and $250,000 (joint filers) would then avoid the increase in Medicare taxes from 1.45% to 2.35%.

Business-level deductions and income for pass-throughs

S corporation shareholders and partners in a partnership are taxed on business income at the individual level, so recognizing business income and deferring business deductions could accelerate taxes for owners.

Many businesses have the power to control the timing of deductions and income based on the regulatory tests that determine when income is recognized or liabilities are taken into account. But be careful. Accounting method changes and other depreciation decisions can delay deductions, and decisions on advanced payments can accelerate income — but these decisions will continue to delay deductions and accelerate income incrementally in future years. It is NOT likely that there are many situations where these decisions will help.

Pass-through businesses, however, can easily control when to recognize capital gain. You can trigger gain and pay tax on stock and other securities without changing position. There is no wash sale rule on capital gains, so stock can be sold and bought back immediately to recognize the gain. If much of the net worth of your business is tied up in one asset because you're deferring the tax bill on a large gain, this might be a good time to reallocate that equity. Turning over assets besides securities will likely involve higher costs and more complications. Strategies that seek to recognize gain but allow a taxpayer to retain some control or use of the assets must satisfy rules that determine whether ownership has indeed been transferred effectively.

Taxpayers can also consider electing out of the deferral of gain recognition available for an installment sale. Deferred income on most installment sales can be accelerated by pledging the installment note for a loan.

Special opportunities exist for converted S corporations. Normally, distributions from a profitable S corporation are considered to come first from the income passed through to shareholders and taxed at their level. To prevent double taxation, these distributions are considered nontaxable to the extent they do not exceed the amount in the S corporation's accumulated adjustment account. However, an S corporation may elect to treat the distribution as first coming out of accumulated earnings and profits, and thus as being taxable. If insufficient cash is on hand, an election to make a "deemed" distribution is available under the S corporation regulations.

Special considerations for Medicare tax

The new Medicare tax on investment income includes an exception for active trade or business income and gain on the sale of trade or business assets or S corporation shares. Owners in pass-through businesses should start thinking of strategies to deal with the Medicare tax before it takes effect in 2013. If it is possible to reorganize business interests and activities so that they meet the test for active rather than passive income (without causing it to be considered self-employment income) this may save taxes in the future.

Corporation shareholder strategies

C corporations will not face any tax increases at the entity level, but shareholders will be concerned with the tax on distributions and the capital gains rate on their ownership interests. While publicly held C corporations cannot realistically tailor action to suit thousands of shareholders in different positions, privately held corporations should have opportunities.

The easiest way to allow shareholders to recognize income while the dividend rate is 15 percent is simply to pay dividends to them now. But many corporations will not be ready to distribute earnings. Instead, consider distributing dividends to shareholders with shareholders immediately recontributing the dividend back to the corporation — or issuing a note to shareholders. Mere bookkeeping entries may not be sufficient to accomplish the actual distribution and trigger the tax. Care should be exercised to ensure the dividend will be respected for tax purposes. It is also important to remember that distributions in excess of earnings of profit will reduce basis, which may be more valuable in the future if capital gains rates increase.

There are also corporate restructuring transactions that can be used to increase basis or trigger gains and dividends for shareholders. Transferring assets to a corporation in a transaction designed to fail tax treatment under Section 351 can trigger gains in assets and provide a step up to full market value in tax basis that the corporation then amortizes or depreciates. A transaction qualifying as a "cash D reorganization" under Section 368(a)(1)(D) can be used to trigger taxable income as a dividend or capital gain to shareholders. In addition to taking advantage of currently lower capital gain and dividend rates, in certain circumstances, these transactions can be structured with no income or dividend recognition pursuant to the Section 356 "boot within the gain" limitation.

Next steps

A number of strategies are available to deal with coming tax changes, but first you need to be comfortable with your own legislative assessment and understand how the changes may affect your specific situation. Contact Grant Thornton to discuss your business and its options in detail.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.