As the on-going battle over the extension of the payroll tax cuts continues in Congress, those of us in the tax professional community are left scratching our heads and trying to advise our clients on what will happen with respect to income and estate taxes over the next few years. The only thing I can say to my clients with any confidence is that anyone who tries to predict what tax changes may emerge from this Congress is talking through his or her hat. Uncertainty continues to be the theme with respect to tax and fiscal policy in the current political environment of Washington.
To that end, I strongly advise that my clients follow the time honored adage, “Make hay while the sun shines.” In some respects, the current income and estate tax law provide really great opportunities and anyone concerned about higher income tax rates or fundamental changes to our estate tax system would be well served to seize on these opportunities while they still exist.
You can look to prior entries in this blog to highlight many of the taxpayer friendly provisions of the code that are set to expire after 2011 and 2012, but below I am highlighting what I consider to be the big three opportunities.
The purchase of many items of equipment, computer software, and in some limited circumstances, leasehold improvements are available for an additional “bonus” depreciation deduction in the first year the assets are placed in service. For assets placed in service before January 1, 2012, this bonus depreciation is equal to 100 percent of the cost basis of the qualified property. A 50 percent bonus depreciation deduction remains available for qualified property placed in service during 2012.
If you anticipate that your business could use any sort of new equipment, then it would likely be a smart move from a tax perspective to accelerate the purchase and place the assets in service during 2011 or 2012. This is especially true if you can use the deduction to reduce taxable income or to create a net operating loss (NOL) deduction that could be carried back 2 taxable years to offset prior taxable income and generate a tax refund.
Low Income Tax Rates
Currently we enjoy a lower marginal tax rate structure and very favorable 15 percent tax rates on both long-term capital gains and qualified dividends. These rates are currently set to sunset at the end of 2012. This sunset would see increases in the marginal tax rates for most middle and upper income individuals and a return of the 36 and 39.6 percent top marginal brackets. The rate for long-term capital gains will return to 20 percent and it is possible that the rate on dividends may return to the regular ordinary income rate based on your marginal income tax bracket. Beginning in 2013 another 0.9% Medicare tax will apply to wages and self-employment income above $200,000 for individuals and $250,000 for joint filers. Additionally, unearned income such as interest, dividends and rental income will also be subject to a Medicare tax of 3.8 percent to the extent that modified adjusted gross income exceeds these same $200,000 and $250,000 thresholds.
There are proposals on the table to extend the favorable rates beyond 2012, and to potentially overturn the additional Medicare taxes that came into place with the provisions of Healthcare reform, but again none of these alternatives are certain. To the extent that you have transactions pending that could create large amounts of ordinary income or highly appreciated assets, it would be wise to consider accelerating recognition of this income before the end of 2012. Many closely-held C corporations may also want to consider paying out large dividends during 2012 to distribute any earnings and profits while the 15 percent rate still applies to dividends.
Estate and Gift Tax
Under the current estate and gift tax law, individuals have a unified credit that can exempt transfers of up to $5 million dollars from any estate or gift tax liability. This credit amount will increase to $5.12 million for 2012. For married couples working jointly, this provides for the tax-free transfer of up to $10.24 million dollars during 2012. The current rate applied to taxable estate or gift transfers tops out at 35 percent. After 2012, if these provisions are not extended or made permanent, the unified credit amount will drop to $1 million per individual and the top transfer tax rate will skyrocket to 55 percent.
Failure to take advantage of these favorable conditions for wealth transfer could represent a huge missed opportunity for high net-worth individuals and families. This is especially true when you consider that the current economic conditions and low interest rates also provide favorable conditions for the transfer of wealth (See “The Wealth Transfer Silver Lining in the Current Economic Downturn” from this blog November 30, 2010).
The political climate of Washington is fickle and monumental changes to our tax system can be made with the stroke of a pen. The current environment is contentious and marked by a decided sense of gridlock, but with the results of the 2012 election, there could be marked change to the scene. The only logical response to this situation is to plan and make arrangements to take advantage of favorable conditions while the opportunity exists. The tax experts here at Bond Beebe stand ready to help you evaluate your personal objectives and financial position and determine how to make the best of an uncertain environment.