2012 Year-End Tax Planning Strategies
With the economy still in the doldrums, 2012 has not been the greatest year for most individuals. Unemployment remains high, incomes are lower, retirement savings have declined, and many taxpayers are struggling to make ends meet. The government has provided a variety of tax incentives to help weather the economic storm, and you are urged to take advantage of these special tax benefits as well as other strategies to keep your tax bite as low as possible.
- State Estimated Tax Payments - Although the deadline to make the state estimated tax payment for the 4th quarter of the current year is January 15 of the next year for most states, the payment will count as a tax deduction on the federal Schedule A for the current year if that payment is made prior to the end of December.
- Property Taxes - Generally, your property taxes are billed in installments, which is how most people pay them. However, the tax can be paid all at once if doing so provides a greater tax benefit for the current year.
Caution: The preceding two strategies do not benefit taxpayers who are subject to the alternative minimum tax (AMT), since taxes are not deductible to the extent that a taxpayer is subject to the AMT. Taxpayers subject to the AMT may, instead, consider deferring deductible tax payments to the subsequent year.
- Bunch Deductions - If your tax deductions normally fall short of needing to itemize your deductions (that is to say, if the standard deduction you are allowed is greater than the total of tax-allowed expenses), or even if you are able to itemize but only marginally, you may benefit from adopting the “bunching” strategy. For more on this technique, read the article “Bunching Your Deductions Can Provide Big Tax Benefits.”
- Required Minimum Distributions (RMDs) from Retirement Plans - If you are in a low or zero tax bracket this year, it may be to your benefit to withdraw more than the minimum required amount. RMDs generally apply to individuals age 70 ½ and older, but even younger retirees who are not yet required to take a distribution—but who are over 59 ½ years of age—may find this strategy beneficial. If you receive Social Security benefits, IRA distributions can sometimes be planned in order to minimize the taxability of the Social Security income.
- Tax Credit for First Four Years of College - The American Opportunity Credit (AOC) takes the place of the Hope education credit and provides a credit for tuition and certain other expenses of the first four years of college (Hope only applied to the first two years). Thus, even if you used the Hope credit in prior years, you may still qualify for the AOC. The credit is 100% of the first $2,000 of qualified expenses and 25% of the next $2,000. 40% of the credit is generally refundable, which means that taxpayers with little or no tax liability can still benefit from the credit. This credit does begin to phase out for single taxpayers with an AGI over $80,000 ($160,000 for joint filers), and no credit is allowed for taxpayers filing married separate.
Important: The AOC is only applicable to tax years 2009 through 2012. Without Congressional action, 2012 is the final year for this more lucrative education credit. Qualifying tuition and fees that you pay in 2012 for an academic period beginning in January, February, or March of 2013 are eligible to be used in figuring the credit claimed on your 2012 return. Therefore, if payments made in 2012 that apply to 2012 academic periods haven’t maxed out your credit, you should consider making the payments covering academic periods starting in the first 3 months of 2013 before the end of 2012.
- Roth IRA Conversions - If your taxable income is low or a negative amount for the year, it may be appropriate to convert some or all of your taxable traditional IRA to a Roth IRA for little or no tax cost. Taxpayers are able to convert funds in regular IRAs (as well as qualified retirement plans) to Roth IRAs, regardless of their income level.
- Review Estimated Tax Payments and Withholding - Ensure that they are sufficient to meet the “safe-harbor” payment amounts so as to avoid underpayment penalties.
- IRA and Self-Employed Retirement Plan Contributions - The primary purpose of these plans is to provide for your future retirement; whenever you are eligible and financially able, you should always contribute as much as possible. Contributions are also tax-deductible when they are made to self-employed plans and to most traditional IRAs. The benefit derived from this tax deduction is based upon your tax bracket. (Some contributions to traditional IRAs may not be deductible if you also participate in another retirement plan, depending on your income level.) Individuals who simply prefer the Roth option but are barred from making Roth contributions because their income exceeds the AGI phase-out limitations, might consider making a non-deductible traditional IRA contribution and then converting it to a Roth IRA since there are no income limitations on conversions.
- Establish a Retirement Plan - If you are self-employed and do not already have a retirement plan but are considering one, there are several options. Some, such as Keogh or 401(k) plans, must be set up prior to the end of the year. If you are an owner-only business, you should review the article “Owner-Only Businesses Should Consider a Solo 401(k) Plan,” as this plan offers business owners with no employees other than their spouse great benefits.
- Capital Loss Carryovers - If you have carryover capital losses, remember that you may only claim a maximum $3,000 net capital loss on your return; the remainder carries over to the following year. However, you may have some gains that you can take to offset the carryover. (If you sell at a gain but wish to repurchase stock in the same company, note that the wash sale rules do not apply—they only apply to losses—so you will not need to wait 30 days to make the repurchase.) For long-term planning, it is important to keep in mind that the current lower capital gains rates of 0% and 15% are only available through 2012. After that, without Congressional intervention, the rates return to the pre-2003 levels of 10% and 20% (8% and 18% for assets held over 5 years). For more details on this strategy, read the article entitled “Fine-Tuning Capital Gains and Losses.”
- Non-Cash Charitable Donations - If you itemize your deductions and your garage and closets contain never-used items, you might consider donating those items to charity before year-end to increase your deductions. In order to claim a deduction for donated clothing and household goods, they must be in good condition or better, and the donations must be substantiated by a written receipt that includes the name of the charity, dates and location of the donation, and a reasonably detailed description of the property donated. A receipt is not required for items whose value is less than $250 and for which it is impractical to obtain (for example, when items are left at an unattended drop site). If, instead, you decide to sell some of the property, the income is generally tax free, provided that you sell each item for less than your cost or basis in the property.
- Deduct IRA Losses - If a traditional IRA account that includes non-deductible contributions declines in value and the value of all of your IRA accounts combined is less than the sum of your non-deductible contributions, you can take a loss by withdrawing from (closing) all of your IRA accounts. However, this loss is beneficial only if you itemize your deductions and if the loss, along with your other miscellaneous deductions, exceeds 2% of your income (AGI) for the year.
- Prepay Medical Expenses - Beginning in 2013 for taxpayers under the age of 65, the AGI threshold percentage for claiming medical expenses on a taxpayer’s Schedule A will increase from 7.5% to 10%, which is the same as the current threshold percentage for alternative minimum tax (AMT) purposes. Individuals (and their spouses) age 65 (before the close of the year) and older will continue to use the 7.5% rate through 2016. Thus, it may be appropriate to pay outstanding medical bills or pre-pay such things as orthodontics for a child before the AGI threshold increases to 10%. In addition, if you are considering elective deductible medical procedures, such as laser eye surgery, it may be beneficial to have the procedure and pay for it in 2012.
- Prepare For New 2013 Health Care Taxes - Beginning in 2013, higher income taxpayers will be subject to the following two new taxes included in the Affordable Care Act:
- Increased Hospital Insurance Tax - The Hospital Insurance (HI) tax rate (currently at 1.45% for employees and 2.9% for self-employed individuals) will increase by 0.9 percentage points on individual taxpayer earnings (wages and self-employment income) in excess of compensation thresholds for the taxpayer’s filing status. Thus, the wage withholding HI rate will be 1.45% up to the income threshold and 2.35% (1.45 + 0.9) on amounts in excess of the income thresholds. The hospital insurance portion of the SE tax rate will be 2.9% up to the income threshold and 3.8% (2.9 + 0.9) on amounts in excess of the threshold. The income thresholds at which this increase begins is $250,000 for married taxpayers fling jointly, $125,000 for married taxpayers filing separately, and $200,000 for all other taxpayers.
For married taxpayers, this additional tax is based upon their joint income. However, if both spouses work, their employers will only base the withholding on the employee’s individual earnings. Thus, married taxpayers who both work may find themselves under-withheld on HI taxes and will thus be required to pay the uncollected HI tax on their income tax return when it is filed. They may need to take steps to increase income tax withholding or pay or increase estimated taxes in order to compensate.
If you are an employee whose compensation is nearing the threshold amount and you anticipate receiving a bonus early in 2013 that, when combined with your regular wages, will put you over the threshold, you may wish to see if your employer will pay the bonus to you in 2012. However, this strategy requires that the effects of the extra income on your 2012 taxes be analyzed in order to determine whether or not it is beneficial.
- Surtax on Unearned Income - A new surtax called the Unearned Income Medicare Contribution Tax is imposed on the unearned income of individuals, estates, and trusts. For individuals, the surtax is 3.8% of the lesser of:
1. The taxpayer’s net investment income or
2. The excess of modified adjusted gross income over the threshold amount ($250,000 for a joint return or surviving spouse, $125,000 for a married individual filing a separate return, and $200,000 for all others).
“Net” investment income is investment income reduced by allowable investment expenses. Investment income includes income from interest, dividends, annuities, royalties, rents (other than those derived from a trade or business), capital gains (other than those derived from a trade or business), trade or business income that is a passive activity with respect to the taxpayer, and trade or business income with respect to the trading of financial instruments or commodities. For surtax purposes, modified adjusted gross income does not include excluded items, such as interest on tax-exempt bonds, veterans' benefits, and excluded gains from the sale of a principal residence.
In order to avoid or minimize this new tax, higher income taxpayers may wish to alter their investment portfolios to include more of the non-taxable investments mentioned above.
Homeowners should be aware that the gain from the sale of their primary home in excess of the homeowner’s gain exclusion or the gain from selling a second residence is treated as investment income and would be subject to this new tax.
The foregoing are tax strategies that can be employed by most, but by no means all, taxpayers. Please call this office if have questions regarding these issues or others or if you would like to engage in some year-end tax planning. If you experience a substantial increase or decrease in income this year, it may be wise to schedule an appointment before the holidays in order to strategize.
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