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Tis the Season (For Serious Year-End Tax Planning)

December 12, 2012

What you need to know when thinking about year-end tax planning.

Debates regarding the Fiscal Cliff rage on and without Congressional action, unprecedented tax hikes are looming just around the corner.

On January 1, 2013, individual tax rates are scheduled to increase, with the top bracket on ordinary income reaching 39.6% (up from 35%), not taking into account phase outs of itemized deductions and personal exemption, which push tax rates even higher. Dividends, which currently qualify for the preferential capital gain rate of 15% lose that special status and become subject to much higher ordinary income tax rates. The tax rate on capital gains increases from 15% to 20%.

The scheduled increase in tax rates noted above are, by themselves, worthy of planning discussions. But one also needs to consider the new Medicare taxes of .9% on earned income and 3.8% on investment income both of which are scheduled to take effect in 2013. Couple these tax rate hikes with talks of limiting or eliminating certain personal itemized deductions for 2013 (mortgage interest and charitable contributions) and it is easy to understand that the stakes for not planning can be high, not to mention costly.

Taxpayers expecting rates to increase in 2013 should consider the benefits of accelerating income into 2012. A variety of techniques exist to accelerate income including, for example, selling appreciated securities and taking distributions from retirement plans (including converting a regular IRA to a Roth IRA). Those taxpayers who can exercise control of dividend paying corporations should consider seriously the advantages to the individual shareholders of paying a dividend in 2012 rather than in 2013. The tax savings can be as much as 29%.

Similarly, taxpayers expecting tax rate increases may be tempted to defer deductions to 2013 but consideration needs to be made for the possibility that those deductions will be limited. Many clients with charitable goals may decide to make those contributions in 2012 and lock in the known tax advantages rather than risk limitation or elimination.

While tax rates are scheduled to increase, not all taxpayers will be in higher brackets in 2013 versus 2012. Variations in income and deductions from year to year as well as the impact of the alternative minimum tax all impact the planning discussion. For many clients, the classic planning of deferring income and accelerating deductions may still be the right strategy for 2012.

Uncertainty with respect to income tax rates is just one set of tax dilemmas confronted by taxpayers. Dramatic reductions in gift and estate tax exemptions scheduled to take effect on January 1, 2013 (from the current 5.12M down to $1M) also have taxpayers and their advisors scurrying to respond. Significant transfers of wealth are occurring at an unprecedented rate.

There is still time to pursue the many planning options to save what might amount to millions of dollars in estate taxes. These opportunities will be substantially diminished once exemptions hit bottom in 2013. Any member of the KLR Private Client Services Group can assist you with your year-end income and estate tax planning needs. Read more from the KLR Tax Services team on the KLR Global Tax Blog.

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