Baker Tilly Tax Accountants and CPA - Year End Tax Planning


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Year-End Tax Planning

As we write this tax planning letter, the US economy remains stagnant, and many economists are warning of a double dip recession.

In the coming weeks, legislation on deficit reduction must be enacted or spending cuts previously agreed to as part of the debt ceiling debate will automatically be triggered. The 2001 tax cuts are also scheduled to expire, raising taxes on most Americans, not just those earning more than $250,000. Further, the jobs bill that President Obama recently sent to Congress includes numerous tax changes and revenue raisers. While the bill was initially rejected, many of the tax provisions in it could be addressed separately or considered as part of deficit reduction. As we go to press with this letter, Congress has yet to act on these proposals, and the short-term outlook is uncertain at best.

We have no crystal ball giving us insight into what Congress will eventually do, or when they will do it. However, if Congress does act, it likely will be late in the year giving you little time to react. Therefore, starting year-end planning now is essential and having a flexible game plan is critical. The bottom line: The country continues to face difficult economic times, and we believe solid financial and tax planning is needed now more than ever. In this year-end letter, like others before it, we urge you to do your annual tax planning and to conduct a full financial review of your portfolios and estate plan.

What does this mean for you? Our advice is to proceed as if the 2001 tax cuts will expire at the end of 2012, but be ready to adjust your planning quickly if different legislation is enacted before the end of the year. It is quite possible that changes to tax rates, treatment of carried interests, and popular tax breaks will be made in late December as part of a last-minute compromise to avert the automatic spending cuts mentioned above. With this in mind, there are several things to consider.

Super Committee deliberations
As Congress grapples with the deficit reduction mandate, we expect that numerous revenue raisers and tax reform proposals will be brought to the table. A final recommendation from the Joint Select Committee on Deficit Reduction (Super Committee) is not due until Thanksgiving. While no one can be certain of the direction the committee will take, much less what Congress ultimately will pass, we have outlined some of the possibilities.

Expiration of the 2001 tax cuts. The top federal individual rate will revert to 39.6 percent on Jan. 1, 2013. In addition, qualified dividends would no longer be taxed at a 15 percent capital gains tax rate, but rather, as ordinary income taxed at up to 39.6 percent. Corporations with earnings and profits may consider paying larger dividends in 2011 and 2012, if they have the cash available to do so.
Limits on the benefit from itemized deductions to 28 percent for high income taxpayers. Other proposals under consideration by the Super Committee include repealing or reducing the benefit of certain tax deductions, such as home mortgage interest, charitable contributions, and medical expenses.
Increase of the long-term capital gains tax rate from 15 to 20 percent, if not higher. Under current law, this becomes effective Jan. 1, 2013, but could be enacted earlier as part of the deficit reduction plan. In addition, capital gains will be subject to an additional 3.8 percent tax as a result of the health insurance law beginning in 2013. You may wish to consider selling or otherwise disposing of appreciated property and recognize the gain in 2011 (or 2012 if the rate increase is not enacted earlier) to take advantage of the lower rate.
Modifications of inflation adjustments on certain provisions. This includes regular income tax brackets, personal exemptions, itemized deduction phase-outs, and IRA contribution limits and deductions.
Taxation of income related to carried interests. Income could be taxed at ordinary rates as opposed to capital gains rates.

Even if Congress is not able to pass these or other tax reforms, the end of 2012 will see numerous changes, including the expiration of the 2001 tax cuts, favorable estate and gift exclusions and tax rates, the alternative minimum tax (AMT) patch, and low tax rates for long-term capital gains.

Given that Congress has struggled to reach consensus on major issues, we very well could face the automatic spending cuts that are part of the Budget Control Act of 2011, more commonly known as the debt reduction act. Keep in mind the automatic increases in tax rates due to the expiration of the 2001 tax cuts do not count toward the deficit reduction as they are current law. However, some in Congress want to make the 2001 cuts permanent, while others simply want to postpone their current expiration date. Accordingly, the tax rate structure will likely be part of Super Committee discussions.

If the Super Committee recommendations fail to become law, the following would occur:

Automatic, across-the-board spending cuts in defense and nondefense discretionary spending, Medicare (capped at 2 percent), farm and housing subsidies, and some smaller entitlements. Ultimately, this will mean a 10 percent decrease in defense spending and an 8 percent decrease in nondefense discretionary spending over the next 10 years.
Social Security, veterans’ benefits, civilian and military retirement pay, and all low-income subsidies (including Medicaid, food stamps, etc.) would be exempt from the trigger.
There is no mechanism within the legislation to increase taxes. The Super Committee needs a majority vote (7 of 12 members) to include any tax increase or new taxes in the deficit reduction legislation.

To help you with your year-end tax planning strategy, visit the links below to read more about the challenges and opportunities of some of the most pressing tax-related issues:

Your 2011-2012 Tax Planning Guide is here.
Looking for additional ways to help minimize your tax liability? Reduce your taxable income by taking advantage of every tax break to which you are entitled. This is what our 2011-2012 Tax Planning Guide is designed to help you do.

Contact our tax services team >