Tax Changes Coming into Effect in 2013

With 2013 fast approaching and the Supreme Court’s decision to uphold the Patient Protection and Affordable Care Act, substantial tax law changes are looming for many Americans.  The sunset of the “Bush tax cuts” is to take place at the end of this year, ushering in higher tax rates and a return to many pre-2001 policies.  This means individuals and businesses will need to plan ahead.  We have outlined a few key-changes below.

Income tax rates

• 2012 top rates:  Ordinary income – 35%; Long-term capital gains – 15%; Qualified dividend income – 15%
• 2013 top rates:  Ordinary income – 39.6%; Long-term capital gains – 20%; Qualified dividend income – 20%

Medicare surcharges

• 3.8% surcharge on unearned income (i.e., interest, dividends, capital gains, passive income, including from partnerships and S corporations in which the taxpayer does not materially participate).
• Applicable to taxpayers with adjusted gross income for 2013 exceeding $250,000 for married couples and $200,000 for single individuals.  Thus, maximum long term capital gains rate in 2013 will be 23.8% and maximum rate on dividends will be at 43.4%.
• 0.9% additional Medicare tax on compensation of more than $200,000 for an individual or $250,000 for married couple, imposed on both wages and self-employment income.

Itemized deduction limitation

• Certain itemized deductions will again have a limitation equal to the lesser of (a) 3% of the adjusted gross income over the “applicable amount” (expected to be approximately $170,000) or (b) 80% of the amount of the itemized deduction otherwise allowable for the taxable year.

Estate and gift tax rates

• 2012 exemption amount: $5,120,000 per person
• 2013 exemption amount:$1,000,000 per person
• 2012 top rates:  Gift tax – 35%; Estate tax – 35%
• 2013 top rates:  Gift tax – 55%; Estate tax – 55%

INCOME TAX PLANNING
In view of the uncertainty as to whether any legislative compromise can be reached prior to year-end, tax-planning will be critical during the second half of 2012.  While immediate action may not be necessary, a thorough review of your income tax situation for 2012 and 2013 is a must in the near term in order to plan for prudent decision making before year-end.

Common year-end income tax planning decisions:

• Recognize capital gains in 2012 or 2013
• Recognize capital losses in 2012 or 2013
• Potential acceleration of ordinary income in 2012 vs. 2013
• Timing of itemized deductions to maximize taxable benefit
• Convert traditional IRA into a Roth IRA in 2012
• Consider reconfiguring portfolio

The increasing tax rates and Medicare surcharge also may drive investment and income decisions for 2013.  With qualified dividend income set to be taxed at a maximum 43.4% rate instead of the current 15%, the allocation of your current investment portfolio may result in a lower after-tax rate of return than a portfolio designed with the consideration of new tax rates (i.e., more allocated to tax-exempt bonds, non-dividend yielding stocks, etc.).  Coordination between your investment and tax advisors is critical to maximizing after-tax returns if you believe your portfolio may not be currently aligned to account for increased tax exposure.

ESTATE AND GIFT TAX PLANNING
The current gift and estate tax exemption is $5,120,000 per person, but will revert to $1,000,000 per person in 2013.  Without legislative changes, the opportunity to transfer wealth tax-free to future generations declines significantly starting on January 1, 2013.  We recommend meeting with advisors to develop a strategic plan if this will effect you.  The combination of historically low interest rates, large exemption amounts, and in some cases, relatively low asset values, makes it a good time to consider estate planning strategies where the strategy’s success is largely dependent on these factors. 

THE NEXT STEPS
With less than 6 months left before tax law changes take effect, strategic income and estate tax planning is more important than ever.  We encourage you to consult with your advisors on your specific situation to develop a strategy to minimize your tax exposure and prepare for the changes ahead.

For more information, please contact Bergan Paulsen.