Top 12 Year-End Tax Planning Tips for 2012

By Alan L. Olsen, CPA, MBA (Tax)
Greenstein, Rogoff, Olsen & Co., LLP

The re-election of President Obama and the division between the Senate and House of Representatives has made year-end tax planning for 2012 a little more difficult than in prior years. It is unclear whether tax legislation will be passed before the December 31st deadline to extend the Bush Tax Cuts as they are set to expire at the end of this year. If they do expire, tax rates will increase in 2013 making now an important time to take advantage of the lower tax rates for what is left of 2012. The following is a list of a few important changes set to begin January 1, 2013:
  • Bush-era taxes are set to expire at the close of 2012. The top tax bracket for ordinary income will increase from 35% to 39.6%.
  • Dividends and short-term capital gains will be taxed at the same rate as ordinary income in 2013. The long-term capital gain rate will increase from 15% to 20%.
  • ‘Obamacare’ (Affordable Care Act) taxes of 3.8% on unearned income (e.g. investment income) and 0.9% on earned income (e.g. wages) of high-income taxpayers will begin in 2013.
  • The alternative minimum tax (AMT) patch will expire. This will cause the amount of income exempt from the AMT to decrease and remove credits against the AMT causing 26 million additional taxpayers to owe the AMT.
  • The adoption credit, wind energy credit, and American Opportunity Credit expire.
  • There will no longer be an above-the-line deduction for qualified tuition expenses.
  • Estate and gift tax top rate will increase from 35% to 55%, and the lifetime gift exemption amount will decrease from $5 million to $1 million.
  • The generation-skipping transfer tax rate will increase from 35% to 55%, and the exemption will decrease from $5,120,000 per person to approximately $1,390,000.
California state taxes are changing as well. The passing of Proposition 30 will increase the tax rate for high-income earners from 10.3% to 13.3% as of January 1, 2012. California does not have a separate rate for capital gains; the above rate will apply to all income. California currently requires all taxpayers with over $1 million in income to pay estimated taxes on a quarterly basis based on current-year projected tax liability. The tax increase caused by the passing of Proposition 30 will not cause an underpayment penalty insomuch as the underpayment is due to the increase in the tax rate. It is important to note that for those of you who had restricted stock units vest, exercised non-qualified stock options, or had large W-2 bonuses, your employer only withheld tax at a rate of 10.23%.

Overall, the passing of Proposition 30 requires you to put more aside for state taxes as well as evaluate your portfolio as the after-tax return on investments taxable in California has become less attractive. You might consider allocating more to California bonds, finding investments with higher yields, or increasing your fixed-income allocation.

Before making any changes or adjustments, you should carefully examine how much you make, spend, and save as well as what can be deducted. Finally, watch out for the AMT in all of your planning because what may be a great move for regular tax purposes may create or increase the AMT.

It may be prudent to prepare your strategies now, but hold off on acting on them until closer to year-end, or until Congress can come to an agreement. With that in mind, we recommend the following tried-and-true tips for your year-end tax planning:

1.  Sell ‘loser’ stocks to offset gains. You may have a mix of winner and ‘loser’ stocks – if you have a big gain, sell some of the ‘loser’ stocks. You can erase a large gain with a corresponding loss. If you expect a big gain in 2013, make sure to sell the ‘loser’ stocks in 2013 to offset the higher tax rate. You might also consider selling greatly appreciated stocks in 2012 to take advantage of the lower capital gains tax rate, and then repurchase the stock after 31 days creating a higher cost basis for any future gains that will be taxed at a higher rate.

2.  Expense business assets under Section 179. If you own your own business and have plans to buy office furniture, equipment, or other tangible business property, you might consider doing so before year-end to take advantage of the temporarily increased Section 179 deduction and/or the temporary 50% bonus depreciation. For 2012, the new rule sets the maximum amount a taxpayer may expense under Section 179 to $139,000 and the phase-out threshold amount to $560,000. In addition, a first-year 50% bonus depreciation deduction is available for qualified properties acquired and placed in service through December 31, 2012.

3.  Contribute money to retirement accounts. The maximum 401(k) contribution is $17,000 for 2012. Payroll deductions can increase your take-home pay because they reduce your taxable income. Some employers allow catch up for the current year. Other types of qualified retirement plans are available to you if you own your own business. In a defined contribution plan, the maximum that may be contributed to a participant’s account is limited to the lesser of $50,000 or 100% of the participant’s annual earnings. In a defined benefit plan, the maximum amount that may be contributed is the lesser of $200,000 or 100% of the participant’s average compensation for his or her highest three consecutive calendar years. It is important to note that the contributing the maximum amount during the year does not always lead to the largest deduction. Please consult a tax professional to know what is best for your situation.

4.  Do a Roth IRA conversion. For 2012, no matter how high your income is, you are allowed to take advantage of the Roth conversion strategy; however, there is no longer the option to defer taxes due because of the conversion. Conversion income is taxed at ordinary rates which are expected to increase in 2013.

5.  Prepay state and/or local taxes. If you expect your income to be lower next year, and you will not be affected by the AMT (sometimes, the acceleration of deductions can cost you money if it triggers the AMT), you should make additional state and local tax payments and take the deduction this year.

6.  Make charitable contributions. Donate and save receipts for deductions on your return. If you have appreciated stock that has been held for more than one year, hold on to your cash and donate the stock. With this strategy you avoid tax on appreciation but can deduct the full value of the stock – everyone wins.

7.  Accelerate discretionary medical expenses: Currently medical expenses must exceed 7.5% of adjusted gross income to be deductible. That percent is set to increase in 2013 to 10% for taxpayers less than 65 years old. If you are close to the 7.5% mark, you might consider spending more on elective or unreimbursed medical procedures and products or prepay medical expenses to increase your deduction in 2012.

8.  Think green- take a tax credit. Although the energy tax credit has been greatly reduced since 2011, a taxpayer can still receive a generous 30% tax credit with no upper limit on geothermal heat pumps, solar water heaters, solar panels, fuel cells, and wind generators.

9.  Don’t overlook other tax credits. Tax credits can be more valuable than deductions. Here are some of the ‘big’ ones:
  1. Child Tax Credit: $1,000 for each qualified child under the age of 17.
  2. American Opportunity Credit: The maximum allowable credit is $2,500 per student for each of the first four years of post-secondary education and 40% is refundable. This credit expires at year end, and the original Hope scholarship credit will continue. The Hope scholarship credit covers only tuition expenses for the first two years of secondary education.
  3. Lifetime Learning Credit: Up to $2,000 – part-time and graduate students can qualify.
  4. Child and Dependent Care Credit: If you paid someone to care for your child(ren) under the age of 13 so you could work, you are entitled to up to $3,000 paid for one qualifying individual or $6,000 for two. The credit will be between 20% and 35% of the expenses depending on your income.
  5. Adoption Credit: Although it is less than in previous years, taxpayers can receive a refundable credit of $12,650 per adopted child.
10.  Gift your money at a low rate. For 2012, the top gift tax rate remains at 35% with a lifetime gift exemption of $5 million. If no new tax legislation is passed before January 1, 2013, the top gift tax rate will become 55% and the exemption will decrease to $1 million. Now is a good time to consider when to make a gift to your children as well as what estate tax planning strategy is best for you.

11.  Take advantage of the current generation-skipping transfer tax rate. The generation-skipping transfer tax (GST) rate will increase by 20% beginning January 1, 2013. The GST exemption amount will also decrease by approximately $3.7 million making the remainder of 2012 a great time for wealthy individuals to gift assets to grandchildren or other skip persons.

12.  Take advantage of “portability” rule for an estate: A newer tax provision allows a surviving spouse to utilize an unused exemption from the spouse who has passed away, so a married couple can exempt up to $10 million. If this is the case for your family, do not forget to make the election on the estate tax return to take advantage of this “portability” rule.

As always, these are general guidelines, and we suggest you consult with a tax professional regarding your particular situation before taking any action. For additional information please contact Alan L. Olsen, CPA, MBA (Tax) at Greenstein, Rogoff, Olsen & Co. – (510) 797-8661.