We have all heard that significant tax provisions will expire on December 31st unless Congress takes action before then. Exactly how will this problem affect your wallet? And what, if anything, can you do about it? Nearly all income levels will be touched in some way by this situation. We’ll discuss some of the ways you might see the effect, but first a warning.
Tax Software Warning
CPAs are staying on top of the moving target of last minute tax laws. However, the consumer tax-preparation software companies might not be able to respond as quickly to late changes in the law. If you use such software to prepare your 2012 tax return, be careful to get an up-to-date version that includes all the last minute tax law changes. If you have ever considered working with a tax CPA, this would be the year to do it.
Smaller Take Home Pay
If you receive a W-2, you have a paycheck. If Congress does not act, the tax withholding on your paycheck is going up. Thus your take home pay in 2013 could shrink. Payroll tax rates are increasing by 2%. For example, if your 2012 gross salary is $70,000 stays the same in 2013, your take-home pay will decline by $1,400 solely due to this payroll tax increase.
Affordable Health Care Act Affects Tax on Investments
Buried in the 1,990 pages of the Affordable Health Care Act is a provision that increases income tax on investments by 3.8%. No act of Congress will change this. Jodi Jones, CPA with Seidel, Schroeder & Company, advises that, with careful tax planning and action on your part, you may be able to minimize the 2013 tax law impact. It would involve “acceleration of capital gain transactions.”
The Dreaded Alternative Minimum Tax (AMT)
Congress intended Alterative Minimum Tax (AMT) for high-income taxpayers. The tax was never indexed for inflation. This may seem like a minor point, but when it affects your tax liability, it can be a big deal. Over the years, more taxpayers have been paying AMT. A range of factors causes you to qualify for AMT, including your income level (between $100,000 and $200,000) and the number of children you claim as dependents. The more you claim, the more likely you are to pay AMT, because of the complex AMT calculations that include claiming children as dependents.
You can’t do anything about the number of children in your family, but you can time certain deductions that could affect when you will pay the higher taxes via AMT. For example, you might be able to reduce the impact of AMT this year by paying your property taxes before year-end. According to James Larkin, CPA with Thompson, Derrig & Craig, more than 26 million taxpayers will pay AMT for the first time this year. The increased tax for them will average $3,700. If you want to try to avoid AMT, seek the advice of a tax CPA soon.
Let’s set the stage with a broad definition of what is in an estate and what is not. In general, an estate includes all assets owned by the decedent. As with all tax topics, you should consult a CPA to determine how estate taxes relate to your unique situation.
Generally speaking, a taxable estate includes:
- Personal residence
- Other real estate
- Family business
- Mineral interests
- Investments in non-family businesses, partnerships and the like
- Undivided interests in partnerships, land, mineral interests and the like
- Life insurance policies
Know the Size of Your Estate
Do you really know how large your taxable estate is? Jones explains “mineral interests are often not considered. In parts of Texas, the market value used in determining estate value can be quite large.” So don’t assume the estate tax changes don’t apply to you because your estate is too small. It might be larger than you think. Check with a CPA this week and find out what, if anything, you need to do before December 31st to come up with the taxable value of your estate.
Possible Estate Law Changes and How They Might Affect You
Under current law through 2012, if your estate is valued at more than $5 million, the amount over $5 million would be taxed at 35% when you pass on. This is called a $5 million exemption. As of January 1, 2013, if your estate is worth more than $1 million, the amount over $1 million will be taxed at 55% when you pass on. This is called a $1 million exemption. There are ways to reduce your gross taxable estate, such as through gifting or giving your children property. These are beyond the scope of this article. See a certified public accountant for details of how this could apply to you.
Let’s look at a simplified example for a $6 million estate. If you pass away on December 29, 2012, your taxable estate would be $1 million and your resulting estate tax could be $350,000. Under the 2013 rules as they currently stand, if you pass away on January 2, 2013, your taxable estate would be $5 million and your resulting estate tax could be $2,750,000.
Jones has some clients whose wealth is in land. “This causes some clients significant stress. If their wealth is in land, they might have to sell assets to come up with the cash to pay estate taxes.” To minimize the effect of this significant tax increase, Jones is consulting with her clients to reduce or eliminate their estate tax hit by considering gifts between generations before December 31st. “They must gather their facts and think through all aspects and consequences of the decision. The same is true if they have a family business. Their decisions have to make sound business sense and coordinate with their estate planning. The tax tail should not wag the dog.”
Larkin explains a second estate tax issue that might be of benefit. It’s called portability. Larkin best explains it with an example. Husband and Wife have a combined community property estate of $2 million. Husband dies in 2012 and leaves his $1 million to Wife. Her estate is now $2 million. If the exemption were to stay at $5 million, she would not have an estate tax issue. However, if the exemption is down to $1 million when Husband dies, Wife has an estate tax issue because her estate at $2 million is greater than the $1 million exemption amount. Larkin explains that Wife can avoid her estate tax issue by electing portability. As expected, there are a lot of details that I cannot go into here. However, Larkin tells us, “We have clients who otherwise are not required to file an estate tax return who are filing just to elect this portability feature. Could be a great move if portability carries over in some form into 2013.”
Planning and Predictions
For years it has been standard advice to push income into next year and avoid paying income taxes now. This year, that rule of thumb has been tossed aside. Both Jones and Larkin are advising their clients to seriously think about pushing as much income as possible into their 2012 tax return instead of delaying to the 2013 tax return. There are many uncertainties about taxes in 2013. Both Jones and Larkin are estimating their clients’ income taxes two ways: assuming laws change and assuming laws don’t change. Larkin explains, “We don’t know exactly what 2013 taxation will look like, but it is not going to be better than 2012.”
Just the Tip of the Iceberg
Folks, we have run out of room here. I have left out more tax warnings than I have put in this article. I cringe to think what my fellow CPAs are saying as they read this column. “I can’t believe she left out ….!” If you want to know what those items are and whether or how you can plan to effectively deal with them, I recommend that you do what I have done: meet with a tax CPA pronto.