The exclusive purpose for the information which is provided from this website is to disseminate information, and not to provide tax advice.
 The information below was provided to me by the American Institute of Certified Public Accountants for distribution and dissemination to the clients of all CPAs. While no attempt is being made to speculate on the final outcome from the 2012 election process, it is important that anyone who may possibly be affected by the outcome to understand the tax law changes which may occur in 2013 and be prepared to make the appropriate decisions after the November elections but before December 31, 2012.Â
Dramatic tax increases are scheduled to go into effect in 2013. If your tax liability will be adversely affected by these changes, you should consider proactive, decisive tax planning during the remainder of 2012. The following tax law changes and taxes may be impacted:Â
- Not only are the Bush Administration tax cuts set to expire, but a new 3.8 percent surtax on investment income and a possible reinstated claw-back of itemized deductions could raise the tax rate on ordinary income to as high as an effective 44.6 percent for some taxpayers.
- Similarly, the tax rate on long-term capital gains could increase from 15 percent to 20 percent and the rate on qualified dividends from 15 percent to an effective 44.6 percent.
- Finally, if Congress doesn’t take action, the federal estate tax rate will increase from 35 percent to 55 percent and the exclusion amount will drop from $5,120,000 to $1,000,000.
 There are alternative courses of action that are available to taxpayers in 2012 to offset or minimize the potential adverse financial impact from these tax laws.   The required planning for these likely tax changes is a major undertaking and many clients are beginning the process now rather than waiting for the fall elections.  This is prudent decision because the additional time will allow you to become comfortable with the gifting process and provide time to custom design trusts for your family.
 Gain “Harvesting”
For many taxpayers it will make sense to “harvest” capital gains in 2012 to take advantage of the current lower tax rates. You would sell appreciated capital assets and immediately reinvest in the same or similar assets. You would then hold the new assets until you would otherwise have sold them, so there would be no change in your investment strategy.
Deciding whether or not to use the strategy is not as simple as it might appear on the surface, however, because the lower tax rates must generally be weighed against a loss of tax deferral. By “harvesting” the gains in 2012 you would be paying a lower tax rate, but recognizing the gains earlier. The greater the differential in tax rates and the shorter the time before the second sale the more favorable gain “harvesting” would be.
 In some cases, the correct decision will be clear without doing any analysis. If you are currently in the 0% long-term capital gains bracket, 2012 gain “harvesting” would always be favorable because it would give you a free basis step up. Gain “harvesting” would also be more favorable if you planned to sell the stock in 2013 or 2014 anyway. The time value of the tax deferral would be small compared with the future tax savings.
At the other extreme, if you are currently in the 15% long-term capital gain bracket and plan to die with an asset and pass it on to heirs with a stepped-up basis, there is no reason to recognize the gain now. You would be incurring tax now without any offsetting future benefit. Nor would it make sense to harvest losses to create additional capital loss carryovers. These loss carryovers would be better employed to offset capital gains in the future when rates are expected to be higher.
If you do not fall into one of these categories, you will have to do a quantitative analysis to determine whether 2012 gain “harvesting” would work for you. The decision could be thought of as buying a future tax savings by recognizing gain in 2012. By analyzing the decision in this way, you could measure a return on the 2012 investment over time. If this return on investment exceeded your opportunity cost of capital, gain “harvesting” would make sense.Â
You should immediately contact your financial advisor, CPA, and estate planner to discuss your options and their recommendations.
Planning for the 3.8 Percent Medicare Surtax
For tax years beginning January 1, 2013, the new tax law change will impose a 3.8 percent surtax on certain passive investment income of individuals, trusts and estates. For individuals, the amount subject to the tax is the lesser of (1) net investment income (NII) or (2) the excess of a taxpayer’s modified adjusted gross income (MAGI) over an applicable threshold amount.
Net investment income includes dividends, rents, interest, passive activity income, capital gains, annuities and royalties. Specifically excluded from the definition of net investment income are self-employment income, income from an active trade or business, gain on the sale of an active interest in a partnership or S corporation, IRA or qualified plan distributions and income from charitable remainder trusts. MAGI is generally the amount you report on the last line of page 1, Form 1040.
 The applicable threshold amounts are shown below.
-  Married taxpayers filing jointly                            $250,000
- Married taxpayers filing separately                      $125,000
- All other individual taxpayers                              $200,000
 A simple example will illustrate how the surtax will be calculated.
Example. Al and Barb, married taxpayers filing separately, have $300,000 of salary income and $100,000 of NII. The amount subject to the surtax is the lesser of (1) NII ($100,000) or (2) the excess of their MAGI ($400,000) over the threshold amount ($400,000 -$250,000 = $150,000). Because NII is the smaller amount, it is the base on which the tax is calculated. Thus, the amount subject to the tax is $100,000 and the surtax payable is $3,800 (.038 x $100,000).
Fortunately, there are a number of effective strategies that can be used to reduce MAGI and or NII and reduce the base on which the surtax is paid. These include (1) Roth IRA conversions, (2) tax exempt bonds, (3) tax-deferred annuities, (4) life insurance, (5) rental real estate, (6) oil and gas investments, (7) timing estate and trust distributions, (8) charitable remainder trusts, (9) installment sales and maximizing above-the-line deductions.Â
Accelerating Ordinary Income into 2012
A final opportunity that should be noted is accelerating ordinary income into 2012. Perhaps the best way to do this would be to convert a traditional IRA to a Roth IRA in 2012, if a conversion otherwise made sense. Ordinary income could also be accelerated by selling bonds with accrued interest in 2012 or selling and repurchasing bonds trading at a premium. Finally, you might consider exercising non-qualified stock options in 2012.
 Estate Tax Provisions
 The estate tax exemption is currently $5,120,000 per person and will revert to $1,000,000 on January 1st, 2013 unless Congress acts. The President is suggesting a $3,500,000 exemption. The potential reduction in the estate tax exemption is resulting in many client making large gifts, in trust, for their family. In some instances the trusts are for the spouse, children and grandchildren and in others just for children and younger generations. Most experts would define the savings at 35%, 45% or 55% of the amount gifted over $1,000,000. On a $5,000,000 gift the savings would be $1,800,000 ($4,000,000*45%).
