With April 17, 2012, behind us and Oct. 15, 2012, still a few months away, it might be a good time to start individual clients thinking about 2012 tax planning. We are currently in a situation of uncertainty somewhat analogous to 2010. At the end of last year, the growing list of regularly expiring provisions again expired, and once again they have not been renewed as of this point. The Bush tax cuts from the 2001 and 2003 tax acts will expire at the end of 2012, as they had threatened to do at the end of 2010, and again uncertainty reigns over whether they will be extended.
In 2010, we faced a similar situation and Congress finally extended both in December 2010. In 2012, it is looking like neither issue will be addressed before the November elections. However, the agreement patched into place in 2010 may be more difficult to come by this time. With the economy on a slow mend and the Federal Reserve holding off on further economic stimulus other than holding interest rates low, President Obama appears less likely to agree to an extension of tax cuts for the wealthy. The Republicans have shown no signs of agreeing to anything less than an extension of the Bush tax cuts for everyone. And some deficit hawks are now raising their voices to suggest that letting all the Bush tax cuts expire, perhaps on a phased-in schedule, might be the best course.
As for the regular renewal of expiring "extender" provisions, there is growing talk in Congress that renewal may not be so certain anymore. Republican proposals for lower tax rates assume eliminating some tax entitlements without identifying them. Some of those may be the regularly expiring provisions. Some in Congress have specifically suggested taking a closer look at each provision, rather than just renewing them en masse.
It would be wise for clients to consider what to do should the Bush tax cuts and expired provisions not be extended. Given Congress' propensity for late-year decisions on these matters, and especially during a presidential election year, preparing several contingency plans should not be considered foolish. There may be little time left to execute these plans in late 2012, let alone planning them at that time.
There are also some new 2012 planning concerns not faced back in 2010. In 2013, unless stopped by the Supreme Court, some further tax provisions of the health care legislation are scheduled to take effect, most notably the increased Medicare taxes of 0.9 percent on earned income and 3.8 percent on net investment income for those with adjusted gross incomes over $200,000 ($250,000 for married filing jointly). So what are some of the strategies taxpayers should be thinking about?
ROTH CONVERSIONS
Roth conversions have been a hot topic since the income restrictions went away in 2010. With 2012 being perhaps the lowest tax rates we will see in a while, Roth conversions should be on the agenda as well. While Congress is talking a great deal about lowering tax rates, the deficit realities may limit what is actually doable in that regard. A Roth conversion in 2012 would ensure taxation at 2012 tax rates and make further accumulations in the Roth account tax-free in the future -- assuming, of course, that Congress does not eliminate Roth accounts while it is attacking tax expenditures.
REALIZING CAPITAL GAINS
The stock market has been doing rather well of late. Current maximum capital gain rates of 15 percent would rise to 20 percent in 2013 under current law. Realizing those gains in 2012 would ensure taxation at the current rates. Investors can even immediately repurchase the investments that they desire to hold for a longer period and still recognize the gain in 2012.
Of course, there are proposals to eliminate capital gains taxes entirely. Taxpayers may want to wait until after the November elections to get a better sense of which way the political winds are blowing before deciding whether capital gains taxes are more likely to rise or to fall in the future. Investors may also consider the likelihood of some companies sitting on cash to pay out a special dividend before 2013 if the law threatens to start taxing dividends as ordinary income again.
INVESTING IN TAX-EXEMPT BONDS
One option being discussed as a way to avoid the increased Medicare taxes on net investment income is to shift more investments to tax-exempt bonds. Tax-exempt bonds generally offer a lower return, and an investment portfolio too heavily weighted in such bonds probably does not offer sufficient diversity, but it is one move to avoid the increased taxes on taxable investments.
Obama has proposed that the same categories of wealthy taxpayers that are subject to the increased Medicare taxes also be taxed on their municipal bond investments. Again, taxpayers can judge after the November elections how likely Obama's budget proposals are to gain traction in 2013.
GIFTING TO CHILDREN
The current unified gift and estate tax exclusion of $5 million (actually $5,120,000 for 2012) will revert to $1 million in 2013 under current law. The maximum tax rate will also go from 35 percent to 55 percent. Most taxpayers would be unwilling to accelerate their deaths, but they might be willing to accelerate gifts to take advantage of the current high exclusion amounts.
Neither the Obama administration nor the Republicans are advocating a return to the $1 million exclusion. However, in an impasse, it might happen because no one can agree on how to keep it from happening.
ACCELERATING AND DEFERRING
Normally, taxpayers are advised to try to postpone income and accelerate deductions. In an environment, however, of anticipated higher rates in the following year, 2012 is a year to consider the opposite strategy. Accelerate income to get it taxed at the lower rates of 2012, and postpone deductions so they can offset income in 2013 that would otherwise be taxed at a higher rate than 2012 income.
REQUIRED DISTRIBUTIONS
One of the provisions that expired at the end of 2011 was the provision permitting taxpayers over age 70-1/2 to make IRA distributions directly to charity and avoid taking those distributions into income. Taxpayers who have taken advantage of this strategy in the past and who would like to do so also for 2012 should try to postpone required minimum distributions until after the November elections to see if Congress acts to retroactively extend the provision.
In 2010, when Congress finally acted to retroactively extend this provision, recognizing the difficult position it had put taxpayers in by not acting until December, it enacted a special rule permitting taxpayers to elect to have a qualified charitable distribution made in January 2011 treated as having been made on Dec. 31, 2010. Congress might do something similar again this year, but if taxpayers have already taken required minimum distributions directly, it would be too late to then treat the distribution as going directly to a charity.
ALTERNATIVE MINIMUM TAX
One of the regularly expiring provisions that also expired at the end of 2011 was the increased Alternative Minimum Tax exemption amount. More than 25 million taxpayers would be caught by the AMT in 2012 if Congress did not act to extend the exemption amount. Congress is very likely to extend the exemption amount again, at least until they can agree on fundamental tax reform and get rid of the AMT entirely.
Still, taxpayers should realize that, if they are in the group that would get caught by the AMT in 2012, there are a variety of tax breaks that they may be accustomed to claiming that would not be available to them in 2012 because they are disallowed under the AMT regime.
SUMMARY
Like 2010, 2012 will continue to be a year of considerable tax uncertainty that will make planning difficult. With the growing list of regularly expiring provisions, almost every year becomes more difficult to plan for. In 2012, with the Bush tax cuts expiring, many of the same tax planning issues focused on when those cuts that were scheduled to expire in 2010 also re-emerge.
However, in 2012, we have the additional issue of the new Medicare taxes taking effect in 2013, also made somewhat uncertain by the Supreme Court's consideration this year of the enforceability of those taxes as part of its review of the constitutionality of the health care reform legislation that brought them into being.
Taxpayers may decide that the uncertainty is too much to take any specific action yet this year: They may decide at least to wait until after the November elections to view what 2013 is likely to bring. However, taxpayers will need to be armed with the facts and options available to intelligently weigh those decisions. To do that effectively requires at least some advance consideration.
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH, a Wolters Kluwer business.
