Is it smart to shift income into 2012 from 2013 due to the expected tax increases?

Is it smart to shift income into 2012 from 2013 due to the expected tax increase?
By Jeffrey Brooks, CPA, CFP, MBA for Jbrooks Wealth Advisors, PC, a Professional CPA and CFP Firm jeff@jbrookswa.com 602-687-9900 x101
My recommendation is to not let the “tail wag” the dog and create income in 2012 to avoid the expected higher 2013 tax rates. You should sell an investment or legally create income in 2012 (instead of 2013) ONLY IF IT MAKES GOOD ECONOMIC SENSE!

I expect that the old Bush tax cuts that came from the EGTRRA/JGTRRA tax acts will not be extended because of the gridlock in Washington. However, NO ONE KNOWS!

Dividends are expected to be taxed at ordinary income rates up to 39.6% in 2013, it seems highly unlikely that such dividends also would be subjected to a 3.8% surtax on net investment income. My prediction is that the Congress will act sometime around April 1 which will produce a “log jam” issue for CPA tax preparers.

The negative of making a pre-2013 distribution now is that it is impossible to know what the rates will look like next year.

The election will give us some clue! The best strategy, if possible, would be to do the groundwork now for a possible pre-2013 corporate distribution, and then be in the position to quickly execute such a distribution after the election if it becomes clear that a substantial tax increase on capital gains and dividends will go into effect next year.

Through the end of this year, the so-called Bush tax cuts are locked in place. However, unless Congress takes action and the president approves (whoever he happens to be at the time), individual federal income tax rates will increase in 2013. Here is what is scheduled to happen to high-income individuals.
• For 2013 and beyond, the top two rates on ordinary income, including net short-term capital gains, will increase to 36% and 39.6% (up from 33% and 35%, respectively).
• For 2013 and beyond, high-income individuals may also be hit with an additional 0.9% Medicare tax on part of their wages and self-employment income. However, the additional 0.9% tax was part of the controversial 2010 Healthcare legislation, so it could be repealed or thrown out by the Supreme Court.
• For 2013 and beyond, the maximum rate on most long-term capital gains will increase to 20% (up from 15%). However, an 18% maximum rate will apply to most long-term gains from selling assets that are: (1) acquired after 12/31/2000 and (2) held for more than five years.
• For 2013 and beyond, dividends will be taxed at ordinary income rates, which could be as high as 39.6% (up from 15%).
• For 2013 and beyond, high-income individuals may also be hit with an additional 3.8% Medicare contribution tax on all or part of their net investment income, which is defined to include long-term gains and dividends. However, the additional 3.8% tax was part of the controversial 2010 Healthcare legislation, so it could be repealed or thrown out by the Supreme Court.
• For 2013 and beyond, the phase-out rules for personal and dependent exemption deductions and itemized deductions are scheduled to return with full force. These disguised tax increases will raise effective tax rates on investment income of higher-income individuals just that much higher.
It’s certainly possible that none of the aforementioned tax increases will actually come to pass. However the prudent thing to do is plan for the worst while hoping for the best..
For 2012, a 2.9% Medicare tax applies to salary and self-employment (SE) income. For an employee, 1.45% is withheld from his or her paychecks, and the other 1.45% is paid by the employer. A self-employed person pays the whole 2.9%. Investment income is not subject to the existing 2.9% Medicare tax.
Now for the bad news: starting in 2013 (which will be here before we know it), all or part of a high-income individual’s net investment income will get socked with an additional 3.8% “Medicare contribution tax” unless our Washington politicians take action. (See IRC Sec. 1411 .)
1. Net gain from property held for investment.
2. Gross income from dividends.
3. Gross income from interest.
4. Gross income from royalties.
5. Gross income from annuities.
6. Gross income from rents.
7. Gross income from passive business activities.
8. Gross income from the business of trading in financial instruments or commodities.
Minus deductions that are properly allocable to these income categories.
Exception for Business Activities: Income from categories 1-6 is generally not taken into account for purposes of the additional 3.8% Medicare contribution tax if the income is from a business activity.
Exception to the Exception: Income from categories 1-6 is taken into account if it is from a passive business activity or the business of trading in financial instruments or commodities. For example, net gains from selling passive rental properties could apparently be hit with the additional 3.8% Medicare contribution tax, and so could net gains from selling passive partnership interests and passive investments in S corporation stock.
Exception for Distributions from Tax-favored Retirement Plans: Net investment income for purposes of the additional 3.8% Medicare contribution tax does not include distributions from tax-favored retirement plans and accounts described in IRC Secs. 401(a) (qualified retirement plans), 403(a), 403(b), 408 (traditional IRAs), 408A (Roth IRAs), and 457(b).
Income Threshold and Tax Base. The additional 3.8% Medicare contribution tax will not apply unless Modified Adjusted Gross Income (MAGI) exceeds the Obama MAGI numbers: (1) $200,000 for an unmarried individual, (2) $250,000 for a married joint-filing couple, or (3) $125,000 for those who use married filing separate status. These MAGI thresholds are not adjusted for inflation. MAGI means regular AGI plus the excess of the amount excluded from gross income under the IRC Sec. 911(a)(1) foreign earned income exclusion over any deductions or exclusions that are disallowed under IRC Sec. 911(b)(6) with respect to such excluded foreign earned income. [See IRC Sec. 1411(d) .]
The additional 3.8% Medicare contribution tax will only apply to the lesser of: (1) net investment income or (2) the amount of MAGI in excess of the applicable threshold.
What could 2013 tax rates look like?
1. 23.8% (20% + 3.8%) on net long-term gains in excess of net short-term capital losses (versus 15% for 2012).
2. 23.8% (20% + 3.8%) on net Section 1231 gains from passive business activities (versus 15% for 2012).
3. 43.4% (39.6% + 3.8%) on net short-term gains in excess of net long-term capital losses (versus 35% for 2012).
4. 43.4% (39.6% + 3.8%) on net dividend income (versus 15% for 2012).
5. 43.4% (39.6% + 3.8%) on net interest, royalty, annuity, and rental income (versus 35% for 2012).
6. 43.4% (39.6% + 3.8%) on net ordinary income from passive business activities and net ordinary income from the business of trading in financial instruments or commodities (versus 35% for 2012).

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About Jeffrey Brooks

Jeffrey Brooks, CPA, CFP, MBA since 1976 has specialized in helping clients save significant taxes, help businesses increase their cash flow, revenues and profits while increasing their control and satisfaction. Jeff and his accounting firm sincerely cares about the happiness of his clients.

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