2012 Year End Tax Planning Strategies

The elections are over, and under current law income rates are scheduled to go up.  Income acceleration has not traditionally been front end strategy.  Delaying payment of taxes is usually the driving force.  The same strategy has always applied to postponing deductions.  But with the potential of a new tax law that increases rates, some are trading in the time value of money principles for a bird in the hand approach to taxes this year.  Rising income and capital gain tax rates, as well as new Obamacare Medicare taxes for 2013 are persuading more taxpayers to take a closer look at acceleration techniques.   Broadly speaking, taxpayers who anticipate higher income tax rates after 2012 should explore shifting income into 2012 and pushing deductions into 2013 and beyond, if possible. 

It's important to understand the type of income One is dealing with, however.  Certain types of income can be netted only against certain types of deductions.  So these tactics can backfire if not careful.  The most common of these is capital losses and passive activity losses.  Also relevant is investment income expenses in figuring the new 3.8% Medicare surtax on net investment income.

Capital Gains and Losses - the net of all gains from the sale of capital assets. Net capital losses are only deductible to the extent of $3,000 against ordinary income.  The remainder is carried forward.  Depending on the appreciation locked into the current portfolio, strategies should be considered to either accelerate long-term capital gains, which currently has the certainty of being taxed at the low 15% rate, or increase carryover losses into potentially higher rate years after 2012.

3.8% Net Investment Income Surtax - for tax years beginning after 12/31/12, a 3.8% Medicare surtax will be imposed on the lesser of an individual's net investment income for the year, or the excess of adjusted gross income over $200,000 ($250,000 if married filing joint).  Net investment income is defined as the sum of gross income from interest, dividends, annuities, royalties and rents; income derived from passive activities (like rental real estate); and net capital gains derived from the disposition of property, over deductions allowed.  Tax exempt income is not a component of net investment income.  Gain from the sale of a principal residence is also excluded from net investment income, but only to the extent exempt under the exclusion rules of $250,000/$500,000 of gain.  Those fortunate homeowners with excess gains may want to accelerate any plans to sell into 2012 if the closing can be done in time. 

Even non-investment income such as wages and bonuses, social security payments, and qualified plan distributions also may have a bearing on the potential surtax if those items cause adjusted gross income to exceed the $200,000/$250,000 threshold.  Qualified plan distributions itself, such as IRA's or 401K distributions, are not considered net investment income in calculating the surtax.

Roth Conversions - a Roth conversion now will ensure being taxed at the lower rates.  Food for thought, and it will require specific planning to see if this makes sense.

Advanced Payments and/or Deferred Compensation arrangements - payments received in advance have always been considered income in the year received, provided no restriction has been placed on the income.  Of course, a practical challenge is to persuade the other party to make the payment in advance.  If there is a little negotiating room, a discount may be required.  Run the numbers and use your judgment.  For Deferred Comp plans,  the employee may have some control as to when to execute the deferred comp arrangement. 

Conclusion - The fate of the existing tax structure is still in debate, even as we write this article.  One option is that Washington may punt into January 2013 too.  Will a compromise be reached and rates stay where they are?  Your guess is as good as ours.  Perhaps lining up some strategies may prove to be prudent should you decide to act quickly in the last few days of 2012.