Be aware of expiring tax breaksDecember 10, 2012
By James R. Armstrong, CPA, and Jodi Permenter, CPA
Tax law changes have been in the news a lot lately and with good reason. Practicing optometrists, like other taxpayers, would do well to take a few moments as the end of the year – and the end of many current tax breaks – approaches and consider how pending increases in overall tax rates, the elimination or reduction of many deductions, and the applicability of the Alternative Minimum Tax to more taxpayers could affect their income. In many cases, they may find it could be advantageous to purchase that new instrumentation they have been wanting, make donations to their favorite charities, sell appreciated, long-term assets or take steps to help their children with education costs before the end of 2012.
The Bush-era tax cuts, established largely by the Economic Growth and Tax Relief Reconciliation Act of 2001, were temporary tax provisions originally scheduled to sunset Jan. 1, 2011. President Obama, reasoning that the weakened economy could not stand the blow of increased taxes, extended many of the tax cuts for an additional two years. However, without further legislative action, those tax cuts will expire Jan. 1, 2013, and, along with them, many advantageous tax planning opportunities.
According to the Tax Policy Center, U.S. households will face an average tax increase of $3,446 in 2013. Be sure to consider taking advantage of the following provisions before they sunset.
- Bonus Depreciation: Bonus depreciation rules were originally established in 2002 by the Job Creation and Worker Assistance Act. The provision, geared to boost spending and jumpstart the economy after the 2001 terrorist attacks, allowed a first year deduction of 30 percent of the cost of new capital assets with a useful life of under 20 years. Increased first to 50 percent in 2004, the provision was temporarily increased to 100 percent for 2010 and 2011. The bonus depreciation deferred back to 50 percent for assets purchased in 2012, and bonus depreciation provisions expire completely Dec. 31, 2012. Bonus depreciation will not be available for assets purchased in 2013. If your business is planning to make a capital acquisition of a new fixed asset, it may be worthwhile to discuss doing so before the 2012 year-end with your tax adviser.
- Income Tax Rates: Income tax rates have been historically low for the past decade, but are scheduled to rise in 2013. The highest marginal tax rate is expected to increase from 35 percent in 2012 to 39.6 percent in 2013. Also, as part of the new health care reform, high-income individuals will be subject to a 3.8 percent surtax on the lesser of (1) their investment income or (2) their income over $200,000 ($250,000 for married couples filing jointly). Investment income includes rental income, capital gains, dividends, interest, and royalties, among others.
- Favorable rates for Capital Gains and Qualified Dividends: Qualified Dividends and Long-term capital gains have been taxed at a favorable 15 percent tax rate (0 percent for taxpayers in the 10 percent and 15 percent income tax brackets) since 2001. When the provision sunsets, long-term gains will be taxed at 20 percent, and qualified dividends will be taxed at your marginal tax rates. If you are holding assets that have appreciated in value, consider selling them before year end to claim the gain at the favorable rate. Also, if you enter into an installment sale in 2012, consider electing to recognize the entire gain in the year of the sale rather than recognizing the gain over the payment period.
- Estate and Gift Tax Provisions: Estate and Gift tax law has never been more favorable than it is right now. Due to the high exemption amounts, 2012 is an excellent year to create and implement an estate plan. ou may gift up to $5 million of your estate to your heirs without incurring any gift or estate taxes. Without further legislation, this amount will drop to $1 million starting in 2013.
- Marriage Penalty: The new tax laws will also reinstate the so-called “marriage penalty,” which was eliminated for taxpayers in the lower tax brackets in 2001. The marriage penalty occurs because the tax brackets for individuals who are married filing jointly are “narrower” than the brackets for single filers. This results in married couples paying a higher marginal tax rate than two single filers with the same combined income. In addition, the standard deduction for married couples will no longer be double the standard deduction for single filers.
- Limitation on itemized deductions: The new laws will also reinstate the Pease Amendment, which limits the amount of itemized deductions allowed to high-income taxpayers (those with household incomes in excess of $177,000). Tem-porarily phased out in 2001, the legislation is scheduled to return in 2013. This limitation will be difficult to avoid; it may be beneficial to make charitable gifts before this legislation is reinstituted.
- The Alternative Minimum Tax (AMT) “Patch”: The Alternative Minimum Tax (AMT) is a parallel tax, or a tax that is paid instead of calculated income tax. The AMT is calculated as a flat tax on income, and disallows many of the tax deductions otherwise allowed, such as personal exemptions or the deduction for state income tax paid. It was originally created only to affect very high-income filers, but because the AMT exemption amount was not indexed for inflation, millions of taxpayers now owe AMT each year. Congress has often passed “patches” for the AMT, which temporarily increase the exemption amount, lowering the number of taxpayers affected. The latest patch will expire at the end of 2012, and unless additional legislation is passed, the number of taxpayers paying AMT will increase from 4 million to 21 million in 2013.
- Personal Exemption Phase-outs: Personal exemptions of $3,800 are generally allowed for every member of the taxpayer’s household. For example, a couple with three children would qualify for a $19,000 exemption (5 x $3,800). However, with the reinstatement of Personal Exemption Phase-outs, high-income taxpayers will not be eligible to claim the full exemption.
- American Opportunity Tax Credit: The American Opportunity Credit was first enacted in 2009 and was the most generous higher education tax credit to date. The first $2,000 of qualifying undergraduate college expenses are matched dollar-for-dollar as a tax credit. 25 percent of the next $2,000 spent is also eligible for the credit, making the maximum credit $2,500 per undergraduate college student. The credit is 40 percent refundable. The credit is phased-out for single filers with income between $80,000 and $90,000 (married taxpayers with income between $160,000 and $180,000). The American Opportunity Tax Credit is scheduled to expire in 2013, and will be replaced by the non-refundable Hope Scholarship. The first $1,200 of qualifying expenses will be matched dollar-for-dollar as a tax credit. Fifty percent of the next $1,200 is eligible for the credit, for a maximum credit of $1,800. The 2013 phase-out range for the Hope Scholarship are not yet published, but are expected to be $50,000 to $60,000 for single filers ($100,000 to $120,000 for married filers).
- Child Tax Credit: Under current tax law, a credit of $1,000 per dependent child is available to families, part of which may be refundable. When the current legislation expires, the maximum credit will be reduced to $500 per eligible child and is only refundable in select cases.
- Payroll Tax Changes: A temporary payroll tax holiday reduced the employee’s portion of social security tax from 6.2 percent to 4.2 percent for 2011 and 2012. For the typical American household, this resulted in an additional $1,000 in annual take-home pay. The payroll tax holiday will expire Dec. 31, 2012, and is not expected to be extended. In addition to a higher Social Security tax rate, high-income taxpayers will see additional Medicare tax withheld from their paychecks. Single taxpayers with income in excess of $200,000 (married couples with income over $250,000) will be charged an additional 0.9 percent Medicare tax on wages earned.
Although careful tax planning can help lower your tax bill in 2013, it has its limits, and not all of the new tax hikes can be reduced or avoided. It is important to evaluate how the new tax legislation will affect your income tax bill for 2013. In order to avoid tax penalties and interest, adjust your 2013 estimated tax payments accordingly. While much of the tax legislation for 2013 is still uncertain, taking action before these current measures expire can certainly reduce your tax burden.
Armstrong is a partner in the firm of May & Company, LLP. Permenter is a member of the professional staff of May & Company, LLP. The firm consults with optometrists in 30 states, assisting with their tax planning and preparation, QuickBooks support, and business planning. May & Company was established in 1922 and has offices in Louisiana, Mississippi, and Alabama. Armstrong can be reached at 601-636-4762 or by email at firstname.lastname@example.org.