Year-end tax planning in 2012 will be more difficult than in prior years. Ordinarily, the objective at year-end is to accelerate deductions and postpone income, with the idea being to defer, but probably not avoid, tax.

But 2012 is different, for several reasons. First, there is a likelihood at this point that income tax rates will increase for high-income taxpayers. Second, the preferential rate on long-term capital gains likely will increase and the preferential rate on dividends may disappear entirely. Third, there are tax provisions in the Affordable Care Act that will subject additional income to the Medicare tax. Specifically, wages in excess of $250,000 for a married couple will be subject to an additional .9% Medicare tax and investment income will be subject to a 3.8% Medicare tax to the extent it causes adjusted gross income to exceed a specified threshold ($250,000 for married taxpayers filing jointly).

So, if you’re a high income taxpayer, is the game plan in 2012 to accelerate income and delay deductions? Yes, but not entirely yes. Remember the rules that limited itemized deductions? Those may be returning. In addition, Congress is looking at limitations on the total amount of itemized deductions. Thus, itemized deduction may be worth more in 2012 than it will be in 2013.

As if all that were not complicated enough, there are looming changes in the estate and gift tax rules, the details of which are less predictable than the changes to the income tax rules. Currently, a married couple may pass up to $10 Million free of estate tax to the next generation, with the excess subject to tax at a 35% rate. In the absence of new legislation, the so-called exemption will decrease to $2 Million for a married couple, with the excess subject to tax at a maximum rate of 55%. Ultimately, the exemption amount could land anywhere in between. My guess is that it will land at $7 Million for a married couple, with the excess taxable at 45%. How does all this translate? First, if you have a large estate, see your estate planner immediately to determine whether any action should be taken before 2013.

Second, if you’re not a high income taxpayer ($250,000 of adjusted gross income for a married couple filing jointly, $200,000 of adjusted gross income for a single person), relax. There’s probably just not that much at stake. Yes, there’s a chance that total gridlock in Congress will cause your rates to increase back to pre-2001 levels, but there’s no way to quantify that risk and the effect would not be overwhelming. If you expect to make substantially more in 2013 than 2012, you may want to accelerate income into 2012 to even things out, but going beyond that point could prove to be a bad play. These general rules don’t apply to everyone. For example, if you’re considering converting a traditional IRA to a Roth IRA, 2012 may be the optimal time. If you have unrealized gains in investment assets, it may make sense to accelerate those gains. Even though the increased rates largely are limited to high income taxpayers, the increased rates on capital gains likely will apply to all taxpayers.

Third, if you are a high income taxpayer, you should get together with your tax advisor and consider whether there are opportunities to accelerate income. For example, if you have appreciated stocks, you could sell them and buy them back, thereby triggering the gain (the wash sale rules do not apply to gains). This could you save you 8.8% in tax (15% capital gains rate, as compared to 20% capital gains rate plus 3.8% Medicare tax). There may be various other opportunities to accelerate income (or delay deductions). Among the most common are:

  • Accelerating January bonus compensation to December
  • Maximizing retirement distributions
  • Converting Roth IRAs
  • Triggering unrecognized installment sale income
  • Accelerate billing and collection of business income
  • Declaring special dividends from closely held corporations
  • Postponing mortgage payments
  • Postponing state income tax payments

If your income in 2013 is likely to exceed $380,000, this planning may be especially important. At that level, your marginal income tax rate in 2013 could be 4.6 percentage points higher, and you will be subject to the additional Medicare tax as well. At a minimum, your overall rate increase will exceed 5 percentage points and, on some types of income, it could be exceed 8 percentage points.

This post only touches upon some of the tax law changes that will occur at the end of the year. There are others, and it is quite possible new legislation may be enacted late this year or early next. Thus, the analysis in this post is not intended to be exhaustive. It is general in nature and is not intended as legal advice.