● Individual income tax rates will increase to a maximum of 39.6 percent, long-term capital gains rates will increase to 20 percent, and the qualified dividend rate will cease to be taxed at 15 percent and will instead be subject to the maximum ordinary income tax rate of 39.6 percent.
●Section 179 expense (relating to writing off tangible property) will decrease to $25,000; the 50 percent bonus depreciation provision will expire.
● The estate and gift tax exemption will decrease from $5.12 million to $1 million and estates with assets greater than the $1 million exemption will see tax rates increase next year.
●There will be a new 3.8 percent Medicare surtax on net investment income for certain taxpayers and employee Medicare tax will go up 0.9 percent.
It is imperative to begin planning immediately. You should consider several key strategies that may seem very contrary to traditional planning.
This year, individuals should consider accelerating income while deferring losses and deductions. Consider harvesting gains in your investment portfolio; selling in 2013 could result in more taxes because of the higher capital gains rate.
Alternatively, if you believe the investment will continue to increase in value, consider selling the asset and then repurchasing the security and holding it. The wash sale rules do not prohibit the recognition of gains on the repurchase of the same security. The repurchase will create a clean step-up in basis in the security, further eliminating tax on the original gain at a higher rate. As a corollary, it would be prudent to defer realizing losses until 2013 when they could offset gains that will be taxed at a higher rate.
As noted above, the Section 179 deduction is scheduled to be reduced from $139,000 in 2012 to $25,000 in 2013 if Congress doesn’t take action.
Tangible personal property actively used in a business for which a depreciation deduction would be allowed is eligible for the Section 179 expense. Software is eligible in 2012.
Also scheduled to expire are the elimination of the phaseout of itemized deductions and personal exemptions. Effectively, high-income taxpayers will lose up to 3 percent of their itemized deductions and their personal exemptions. The result of these two eliminations will essentially raise the effective tax rate for high-
income taxpayers without raising the statutory tax rate.
Taxpayers should reconsider the tax deferral provisions of Section 1031 in the future if capital gains tax rates do rise. This section allows the nonrecognition exchange of like-kind property. It is not applicable to all capital assets (stocks, for instance), but it is well-suited for real estate. While capital gains rates were at 15 percent, many taxpayers opted to sell the property, pay the tax and increase the tax basis in replacement property. With the potential increase in capital gains rates, deferring recognition of gains on appreciated property may prove to be a better strategy.
Finally, the proposed changes present planning opportunities in the area of estate and gift.
The annual gift tax exclusion is $13,000 in 2012. The 2012 rate is 35 percent and is scheduled to increase to 55 percent in 2013. The lifetime individual gift tax exemption is $5.12 million for 2012 (the total available exemption for a married couple is $10.24 million).
Any gifts above that amount would be taxed at a 35 percent rate. The exemption is scheduled to decrease to $1 million per taxpayer in 2013, and the rate is scheduled to increase to 55 percent. Therefore, taxpayers should consider making significant gifts before the end of 2012.
Gifts to grandchildren either outright or in trust for their benefit utilizing the $5.12 million generation-skipping transfer tax exemption in 2012 should also be considered. The generation-skipping transfer tax exemption is scheduled to be reduced to $1.4 million in 2013.
Because of the uncertainty about which provisions will expire, be extended or amended, it is critical to develop several tax plans heading into next year. Speak with your tax practitioner soon and follow up through the end of the year as the dust settles, making sure you carefully execute the right plan.
Louis Balbirer is a director of tax services with Kaufman, Rossin & Co. Read the full text of this article at wpost.com/onsmallbusiness.