A Silicon Valley-based CPA is warning taxpayers and their accountants to begin planning for the tax increases that are set to take effect next year unless the current tax rates are extended by Congress and President Obama.

“Many tax rates are set to increase in 2013,” said Rob Trammell, a principal at the San Jose-based accounting firm Abbott, Stringham & Lynch. “This means taxpayers will want to plan now, and monitor that plan to ensure they take appropriate action throughout 2012 before tax rates increase next year.”

Trammell warned that if taxpayers wait until next tax season when they file their 2012 return to assess, plan and take action, it may be too late to fully enhance their tax position. He pointed out that the scheduled 2013 rate increases include the tax rate on ordinary income, additional tax on investment income for high-income individuals, and long-term capital gains tax rates,

“As you consider the impact of these increases, one of the questions you’ll want to ask yourself is does it make sense for me to accelerate income into 2012,” he said.

President Obama proposed tax reforms in his fiscal 2013 budget earlier this month, which calls for the expiration of 2001 and 2003 Bush-era tax cuts for high-income taxpayers earning over $250,000 a year, along with a new minimum tax on millionaires to replace the alternative minimum tax (see Obama Proposes Tax Reforms in 2013 Budget). He hammered out a deal with Republicans in Congress in December 2010 to extend the Bush-era tax rates for two more years for taxpayers at all income levels, but the current tax rates are expected to expire unless Obama and congressional Republicans can agree on another extension by the end of this year. Given the disagreements over tax policy between Democrats and Republicans, and the protracted election season this year, the outcome for the tax rates is expected to depend on the results of the election. Many observers do not believe there will be an agreement until the lame duck session of Congress after the election.

“The highest ordinary income tax rates will increase to 39.6 percent from the current 35 percent,” said Trammell.  “As you ask yourself does it make sense for me to accelerate income, you may want to consider, for example, exercising stock options, which generate ordinary income. As another example, if your employer is due to pay you a bonus in 2013, you may want to see if they’d be willing to pay you that bonus in 2012 instead.”

Trammell noted that, for high-income individuals, there will be an additional Medicare tax of 3.8 percent imposed on either net investment income or modified adjusted gross income, depending upon which is less. Net investment income is defined as unearned income, which includes interest, dividends, royalties, annuities, and rents. Modified AGI is only subject to the tax by the amount it exceeds the following floors: $250,000 for joint filers and surviving spouses, $125,000 for a married taxpayer filing separately, and $200,000 in most other cases with a few exceptions. 

“There are strategies that can be developed to minimize your tax liability, such as using deferred annuities, municipal bonds, or pension contributions to keep modified AGI below the threshold or by maximizing Roth IRA distributions or minimizing limited partnership income to reduce net investment income,” said Trammell. 

“Long-term capital gains rates are scheduled to increase from 15 percent to 20 percent in 2013,” Trammell added. In preparation for these changes, taxpayers should review their stock portfolios, real estate holdings, and other investments with their tax advisors to determine if a sale in 2012 is appropriate, but Trammell cautioned about the hidden costs of installment sales, 

"For example, if I have property that I'm planning to sell in 2012 to a buyer that wants to pay with an installment note, the installment I receive in 2012 will be taxed at a capital gains rate that is 5 percent lower than the rate I'll be taxed at in 2013 and beyond,” he noted. “With planning, I can account for this in my agreement with the buyer and charge a higher price to compensate for the higher tax rate in subsequent years. Otherwise, I could net less than expected."

According to Trammell, everyone has a unique set of circumstances, so they should seek advice from their CPA. “While your tax plan is unique to you, the need to conduct tax planning is not,” he said. “When you meet with your CPA about your 2011 taxes, start planning for the higher tax rates you may see in 2013.”

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