News & Events Listings

President Obama's re-election signals the likelihood of up-coming difficult negotiations between Democrats and Republicans over (1) the fate of the Bush-era tax cuts, (2) nearly $100 billion in automatic spending cuts for the Government's fiscal year beginning October 1, 2013, and (3) whether a long list of recently enacted, but now expiring tax benefits and exclusions, including the AMT patch for 2012 and beyond, will be extended again.  Despite the present level of uncertainty over what is ahead, the one thing that is fairly certain is that year-end tax strategies for 2012 will demand more than normal attention from "higher income" taxpayers and will involve more than the traditional year-end planning advice to defer income from, and accelerate deductions into, the current year.

Q: What are some of the more immediate concerns facing "higher-income" taxpayers for 2012?

A: President Obama has repeatedly called for higher tax rates on single taxpayers with annual incomes above $200,000 and married filing jointly taxpayers with annual incomes above $250,000 (oftentimes referred to by the President as the "wealthy"), while continuing the Bush-era tax rates for all others. He can accomplish the former by ensuring that the Bush-era tax cuts do in fact expire on December 31, 2012 as they are now scheduled to do without any further Congressional action. Extending the Bush-era tax cuts to the non-wealthy would, however, require Congressional action. If the President gets his way, then we can expect the following:

  • the top marginal tax rate for the ordinary income of the wealthy will increase from 35% to 39.6%;
  • In addition, their top marginal tax rate on capital gains would return to 20% and  "qualified dividends" would no longer be treated as capital gain, but rather as any other ordinary income (again, subject to a top marginal tax rate of 39.6%);
  •  And, lest we forget, he is still pushing for some sort of "Buffett Rule" that would subject the income of the super-wealthy (basically those with annual incomes in excess of $1,000,000) to an even higher top marginal tax rate.

His re-election also ensures that the 3.8% "Medicare contribution" tax on the "net investment income" (which is very broadly defined)1 of the wealthy will go into effect on January 1, 2013.

It should also be noted that unless Congress takes action to extend the 2% payroll tax holiday which has been in effect for 2011 and 2012, commencing January 1, 2013 the employee's portion of FICA taxes will return to its pre-2011 level of 6.2% of wages. And, in addition, the taxable wage base for FICA taxes will increase from $110,100 to $113,700 for 2013.

Q: Is there any chance that Congress will simply extend the Bush-era tax cuts for another year while using 2013 to arrive at a "grand bargain" that permanently resolves the fate of the Bush-era tax cuts, fundamentally reforms the corporate tax code, and takes a serious step toward deficit reduction?

A: There is always a chance that such a scenario will play out, but President Obama is on record as not favoring such an approach. Many think that due to Congressional gridlock, Congress will take no action before January 1, 2013, the Bush-era tax cuts will expire for everyone, and sometime in early 2013, the Democrats will propose legislation reinstating the Bush-era tax cuts for the non-wealthy thinking that the Republicans cannot afford to not go along with that approach.

Q: If we assume that the Bush-era tax cuts in fact expire on December 31, 2012, what are some key tax-planning opportunities that higher income taxpayers should take advantage of prior to January 1, 2013?

A: Actually, there are several actions that are of special relevance to higher income taxpayers that they should consider taking before year-end, including some of the following approaches that seem to violate the traditional advice of deferring  income and bunching expenses in the current year:

  • If you are holding capital assets, especially publicly traded securities, that have unrealized appreciation, consider selling it before January 1, 2013. In 2012, the top rate on the gain is only 15%, while after January 1, 2013, the top rate could be as high as 23.8% (20% top marginal tax rate on capital gains + 3.8% Medicare contribution tax on net investment income). In case of publicly traded securities, if the investment is one that you would otherwise want to hold on to for the future, simply re-purchase the security the day after selling. While this technique will not work if you realize a loss on the sale (a so-called "wash sale"), it works just fine in the case where the sale results in a gain. You should be aware, however, that certain sales to "related parties" can convert what would normally be capital gain into ordinary income.
  • If you choose to make a sale of your capital assets in 2012, seriously consider electing out of the installment method of reporting the gain from the sale since by not so doing, the gain which is therefore recognized in subsequent years will potentially be subject to a 23.8% tax rate.
  • If you hold stock in a Sub S corporation which possesses earnings and profits ("E&P") from previous years while it was a Subchapter C corporation, now may be the time to purposely "purge" the E&P of your Sub S corporation by distributing it prior to year end when it will be taxed at a top rate of 15%. If such funds are distributed after 2012, the funds will be subject to a top marginal tax rate of 39.6% plus the 3.8% Medicare contribution surtax.
  • If you have the choice, accelerate any year-end bonuses into 2012, and/or exercise any non-qualified stock options in 2012, when the top marginal tax rate is 35%. After 2012, the top marginal tax rate on bonus income will be 39.6% plus such bonus will also be subject to an additional Medicare tax of 0.9%. By accelerating the bonus, you could save up to 5.5% of the bonus in lower taxes (40.5% - 35%).
  • If you own a traditional IRA, and you have thought about the wisdom of converting it into a Roth IRA, you may want to convert to a Roth IRA before 2013 when the top marginal tax rate increases from 35% to 39.6%.

Q: Other than the new 3.8% Medicare Contribution tax and the new 0.9% Medicare payroll tax that first become effective in 2013 under ObamaCare, are there any other tax surprises for 2013 under ObamaCare?

A: There are two other fairly significant tax provision found in ObamaCare that take effect in 2013.

  • First, employers must limit employee salary reduction contributions to a health flexible spending arrangement ("FSA") to $2,500 as of the FSA's first plan year that begins on or after January 1, 2013.
  • Secondly, an individual can only deduct on Schedule A his out-of -pocket medical expenses that exceed 10%2 (formerly the threshold was 7.5%) of the taxpayer's adjusted gross income.

Q: I keep hearing about ObamaCare's "pay or play" tax penalty that is supposed to take effect in 2014. Will that affect me personally?

A: Not directly. The so-called "pay or play" tax which is provided under Section 4980H of the Internal Revenue Code potentially applies to employers with an average of at least 50 "full-time" and "full-time equivalent" employees. Generally, the tax only kicks in whenever the employer either (i) does not provide a health plan for its employees (sometimes referred to as the "sledgehammer tax"), or (ii) provides a health plan that requires too large a required contribution by the employees (sometimes referred to as the "tack hammer tax").  These taxes will apply if at least one of the employees qualifies for a "premium  assistance tax credit" from the IRS  and  obtains his or her own health insurance under one of the State or Federal Health Exchanges mandated by ObamaCare (referred to herein as "eligible employees"). The tax under IRC Section 4980H can be quite significant. The sledgehammer tax is equal to the product of (a) $2,000, times (b) the total number of the employer's full-time employees less 30.  The tack hammer tax is equal to the product of (a) $3,000, times (b) the number of eligible employees, but in no event can the tack hammer tax ever exceed the amount of the sledgehammer tax if it would have otherwise applied to the employer. In addition, the tax is nondeductible to the employer. Employers subject to these rules will have a decision to make on whether to pay the additional taxes or continue to sponsor their health insurance plans for their employees.

1 For purposes of this 3.8% tax, the term "net investment income" includes interest, dividends, annuities, royalties, rents, "recognized" capital gains, and even "passive activity" income from trade or business activities of the taxpayer. Accordingly, this tax will potentially apply to any capital gain recognized by a wealthy taxpayer upon the sale of his personal residence, but only to the extent that the gain is greater than the applicable tax free threshold amount ($500,000 for married filing jointly taxpayers, $250,000 for all other taxpayers).

2 For 2013-2016, the AGI floor remains at 7.5% of AGI for taxpayers who have attained age 65.

For more information contact your local UHY LLP professional.