Published December 28, 2012
As the year ends, uncertainty surrounds taxes. Many tax laws are scheduled to expire at the end of the year, and the temporary tax cuts that felt so permanent may be at risk if Congress doesn't act soon.
As a result, carrying out year-end tax planning could be a gamble or even a waste of time. It is not just the wealthy who will be affected. Action -- or lack thereof -- taken by Congress before the end of the year will determine whether these tax benefits will be available for the following year for many taxpayers, including:
Which provisions are at risk?
In 2001, former President George W. Bush signed the Economic Growth and Tax Relief Reconciliation Act, which reduced tax rates for all individuals. It included lower rates for taxes on income, capital gains and dividends.
In addition, allowable retirement contributions were increased, estate taxes were reduced, and the alternative minimum tax exemption was raised. The majority of these cuts are set to expire at the end of 2012.
Some tax cuts instituted after the Bush presidency also are at risk. During 2011, payroll taxes were temporarily reduced to help employees and self-employed individuals. These cuts quickly became known as the "payroll tax holiday."
As a result of the holiday, employees and self-employed individuals received a 2% reduction in payroll taxes (from 6.2% to 4.2% for employees, and 12.4% to 10.4% for self-employed individuals).
Originally set to expire at the end of 2011, the so-called holiday was extended through the end of 2012. Since many of these cuts now are set to expire at the end of 2012, and since Congress and President Barack Obama do not see eye to eye, there is little guidance as to what the tax rates will be in 2013.
So what should you do?
Should you accelerate expenses or risk carrying them into next year? Should you accelerate income or defer it? Will rates rise next year? Will they remain the same?
There are so many questions and possibilities that this year, some planning techniques will be nothing more than a huge gamble. You may have better odds playing the lottery than guessing the end result.
Instead, focus on the following safe strategies that are sure to be your best bets no matter what the end of the year may bring.
Planning for your investment dollar
If you have incurred losses on investment holdings, carefully examine your portfolio to determine whether it would be beneficial to realize these losses before the end of 2012. Question whether realizing these losses will generate loss carry-overs to be utilized in later years or whether these losses will create a substantial reduction in income in the current year.
If the realized losses will not create a substantial reduction of current income or a loss carry-over, it may be wise to consider waiting until 2013 or subsequent years to realize the loss.
James R. Washington III, a certified public accountant and tax attorney at Ajubita, Leftwich & Salzer LLC in New Orleans, says capital gains should be given careful consideration.
Washington says many tax advisers are urging clients to sell lucrative investments during 2012 in order to avoid the 3.8% Medicare tax scheduled to be implemented in 2013 and to avoid a possible hike in the capital gains rates.
"However, advisers and investors should be careful," Washington says. "This advice may work for some taxpayers, but not all."
For starters, the Medicare tax will only affect high-income individuals, he says.
"Also, if capital gain rates do not rise, taxpayers who hurriedly dump investments may not gain any benefit, may squander opportunities to defer tax and may lose money on reinvestment expenses," Washington says.
Should you accelerate deductions?
If you are a high-income taxpayer and take advantage of itemized deductions, your deductions may be at risk. Currently, taxpayers may deduct overall itemized deductions without any limitations. However, after Dec. 31, 2012, overall itemized deductions may be subject to certain limitations.
However, this may change next year. Without the necessary legislation, high-income individuals may be subject to a reduction in itemized deductions as high as 80%.
"If you have major medical expenses or employee-related expenses on the horizon, consider incurring the costs in 2012 to avoid the possible consequences associated with waiting until 2013," Washington says.
Give a little
Two key tax provisions scheduled to expire at the end of 2012 are the estate exclusion of $5.12 million and the current top estate tax rate of 35%. Without an extension of these provisions, the estate exclusion level is slated to be reduced to $1 million, and the top rate has the potential to rise to 55%. That can be a hefty tax burden on an estate.
Some taxpayers who fear paying high estate taxes decide instead to give their money to loved ones in the form of "gifts." Gifting assets today may generally reduce estate taxes at death. Currently, taxpayers may gift up to $13,000 (in 2012) per donee, up to an unlimited number of donees, without incurring any gift taxes.
"If taxpayers are contemplating giving gifts in the future, they should seriously contemplate doing so prior to the end of 2012," Washington says.
Transferring highly appreciated assets to donees in lower tax brackets allows the taxpayers who are transferring the assets to reduce their estate. It also gives the donees the opportunity to take advantage of lower capital gain rates, he says.
"These moves may be worthwhile despite the tax uncertainties," Washington says.
However, Washington warns that taxpayers should weigh other factors, such as the "kiddie tax" and the effect of the transfer as it relates to proposed lifetime exclusion amounts for 2013 and subsequent years.
"Taking advantage of the $5 million exclusion may come with consequences if the exclusion amount is reduced in the future and Congress fails to implement provisions to protect those individuals who took advantage of the exclusion available in 2012," Washington says.
Before making gifts in 2012, Washington recommends asking your adviser to carefully calculate the risks associated with the kiddie tax and the possible reduction in the exclusion amounts.
Make a plan to plan
Whether planning on your own or meeting with an adviser, take the time to understand which of these tips will reduce your tax bill. There are many uncertainties at the moment, but taxpayers can successfully save valuable tax dollars by focusing on these steps.
Remember: your choice, your future!
We would like to thank Kemberley Washington, CPA, assistant dean of student programs at Dillard University in New Orleans, for her contribution.
Copyright 2012, Bankrate Inc.