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September 2012 Tip of the Month

It's Just Not Your Tax Advisor's Fault

Abo and Company, like most tax professionals, just don’t believe any significant federal tax legislation will be enacted before the presidential election. Uncertainty creates complexity. Such complexity increases the risk that taxpayers could have lost tax savings opportunities related to tax code changes that become effective at year-end. Details of the “2012 Tax Armageddon” are outlined below.

Without congressional action, most of the tax rate reductions and exemptions enacted since the tax act from 2001 will expire. We suggest you consider the following examples of the changes that will occur at year-end if Congress takes no action.

  • Individual income tax rates will increase with the expiration of the changes made by the 2001 and 2003 tax acts.

  • The estate tax exemption will revert from $5,120,000 to $1,000,000 per person.

  • Federal estate and gift tax rates will increase to a maximum of 55%.

  • The election to use a deceased spouse’s unused exclusion from estate tax will expire.

  • For married couples filing joint tax returns and qualifying widows and widowers, the alternative minimum tax exemption will revert from $74,450 to $45,000.

  • An additional 2% tax on self-employment income will occur.

  • The “bonus depreciation” option for fixed assets will expire and the section 179 deduction (i.e. expensing fixed asset purchases) will be reduced from a maximum of $139,000 to $25,000 and the phase-out threshold will be reduced from $560,000 to $200,000.

  • Many temporarily extended tax provisions will expire December 31, 2012, including but not limited to the increased dependent care credit, refundable credit for prior year minimum tax liability and exclusion from gross income for discharge of indebtedness on the principal residence.

  • The Medicare tax rate on earned income exceeding $200,000 ($250,000 for couples filing a joint income tax return) will increase from 1.45% to 2.35%.

  • Net investment income will generally be subject to a 3.8% additional tax to the extent AGI exceeds $200,000 ($250,000 for couples filing a joint tax return) effective January 1, 2013.

Here’s an example of an interesting tax calculation we’ve been reminded of:

  •             Federal tax rate of qualified dividend income in 2012 is 15%
  •             Federal tax rate of qualified dividend income when/if the tax cuts expire will be 39.6%
  •             Additional Medicare tax on investment income for top earners beginning in 2013 will be 3.8%

Soooo…the tax on that dividend income for many of our clients is scheduled to jump from 15% to 43.5%

Please note, however, that we suspect many of the scenarios listed above may not actually occur. Our “trusted” elected officials have made a habit recently of walking the tightrope with the legislative deadlines and extending provisions at the final hour. While this may very well be the case again, even some or partial enactment of these items can greatly affect our clients.

The election year debate on tax reform and uncertainty regarding which provisions will survive the election cycle represents a substantial challenge for everyone, especially tax professionals like us at Abo and Company struggling to provide valuable tax planning advice to our clients. There just does not appear to be a clear picture of the 2013 tax rules,

Everyone cannot just wait until December (or worse, after) to address year-end tax planning. Frankly, everyone, as taxpayers, needs to understand the implications of congressional action or inaction applicable to your taxes and will require time to consider decisions that may need to be deferred until shortly before the end of the year.

As soon as some of the expected legislative compromises come into focus, consider calling us for an appointment to see what effect this will have on your individual situation.