2012 Year-End Tax Planning for Individuals
As the end of 2012 is drawing within view, it is time to consider year end planning for 2012 and looking forward to the uncertainty that potentially looms for January 1, 2013. As the year draws to a close, many taxpayers are asking how they can plan in light of the uncertainty surrounding the fate of the Bush-era tax cuts and other expiring tax provisions and incentives.A host of reduced tax rates, credits, deductions, and other incentives (collectively called the “Bush-era” tax cuts) are scheduled to expire after December 31, 2012. To further complicate planning, over 50 tax extenders are up for renewal, either having expired at the end of 2011 or which are scheduled to expire after 2012. At the same time, the federal government will be under sequestration (aka "The Fiscal Cliff"), which imposes across-the-board spending cuts after 2012. The combination of all these events has many referring to 2013 as “taxmaggedon.”
Expiring ProvisionsEffective January 1, 2013, the individual income tax rates, without further congressional action, are scheduled to increase across-the-board, with the highest rate jumping from 35 percent to 39.6 percent. The current 10-percent rate will expire and marriage-penalty relief will sunset. Additionally, the current tax-favorable capital gains and dividends tax rates (15 percent for taxpayers in the 25-percent bracket rate and above, and 0 percent for all other taxpayers) are scheduled to expire. Higher-income taxpayers will also be subject to revived limitations on itemized deductions and their personal exemptions. The child tax credit, one of the most popular incentives in the Code, will be cut in half. Millions of taxpayers would be liable for the alternative minimum tax because of expiration of the AMT “patch.” (Note that the AMT patch also has not been extended for the 2012 tax year.) Countless other incentives for individuals may either disappear or be substantially reduced after 2012. While a divided Congress may indeed act to prevent some or all of these tax increases, a year-end planning strategy that protects against worst-case scenarios may be especially wise to consider this year.
Income tax withholding. Expiration of the reduced individual tax rates will have an immediate impact. Income tax withholding on payrolls will immediately reflect the increased rates. One strategy for taxpayers to avoid being surprised in 2013 is to adjust income tax withholding. Keep in mind that the current 2-percent payroll tax holiday (for the employee portion of Social Security) is also scheduled to expire after 2012, so it is a good time to review if a taxpayer is having too much or too little federal income tax withheld from pay.
As mentioned, traditional year-end planning techniques should be considered along with some variations on those strategies. Instead of shifting income into a future year, taxpayers may want to recognize income in 2012, when lower tax rates are available, rather than shift income to 2013. Another valuable year-end strategy is to run the numbers for regular tax liability and AMT liability. Taxpayers may want to explore whether certain deductions should be more evenly divided between 2012 and 2013 and which deductions may qualify, or will not be as valuable, for AMT purposes.
Harvesting losses. Now is also a good time to consider loss-harvesting strategies to offset current gains or to accumulate losses to offset future gains (which may be taxed at a higher rate). The first consideration is to identify whether an investment qualifies for either a short-term or long-term capital gains status, because short-term gains are first offset with short-term losses and long-term gains with long-term losses. Remember also that the wash-sale rule generally prohibits taxpayers from claiming a tax-deductible loss on a security if the taxpayer repurchases the same or a substantially identical asset within 30 days of the sale. If you have long-term gains, it may be worth considering recognizing the gain this year while long term capital gains rates are at historically low levels and scheduled to increase in 2013.
Education expenses. Taxpayers with higher educational expenses may want to consider the scheduled expiration of the American opportunity tax credit after 2012 in their plans. The AOTC (an enhanced version of the Hope education credit) reaches the sum of 100 percent of the first $2,000 of qualified expenses and 25 percent of the next $2,000 of qualified expenses, subject to income limits. If possible, pre-paying 2013 educational expenses before year-end 2012 could make the expenses eligible for the AOTC before it expires. The “regular” Hope credit, and another popular education tax incentive, the Lifetime Learning credit, are not scheduled to expire after 2012.
Job search expenses. Some expenses related to a job search may be tax deductible. There is one important limitation: The expenses must be spent on a job search in the taxpayer’s current occupation. A taxpayer may not deduct expenses incurred while looking for a job in a new occupation. Examples of job search expenses are unreimbursed employment and outplacement agency fees paid while looking for a job in the taxpayer’s present occupation. Travel expenses to look for a new job may be deductible. The amount of job search expenses that may be claimed is limited. A taxpayer can claim the amount of expenses only to the extent that they, together with other miscellaneous deductions, exceed 2 percent of the taxpayer’s adjusted gross income.
Gifts. Gift-giving as a year-end tax strategy should not be overlooked. The annual gift tax exclusion per recipient for which no gift tax is due is $13,000 for 2012. Married couples may make combined tax-free gifts of $26,000 to each recipient. Use of the lifetime gift tax exclusion amount ($5.12 million for 2012) should also be considered. Without congressional action, the lifetime exclusion amount drops to $1 million in 2013.
Charitable giving. For many individuals, charitable giving is also a part of their year-end tax strategy. Under current law, the so-called “Pease limitation” (named for the member of Congress who sponsored the law) is scheduled to be revived after 2012. The Pease limitation generally requires higher income individuals to reduce their tax deductions by certain amounts, including their charitable deductions. A special rule for contributing IRA assets to a charity by individuals age 701/2 and older expired after 2011 but could be renewed for 2012.