Year End Tax Planning for Individuals 
As a taxpayer, you are facing what is perhaps an unprecedented set of circumstances – the expiration of the tax rates enacted in 2001, the expiration of more than 150 tax provisions and a tax increase of more than $500 billion overall – that could result in a much higher tax liability when you file your next return.
If Congress and the President do not make changes, the combined effect could result in an average tax hike of around $3,500 per household for up to 90% of Americans. We want to inform you of possible tax increases and loss of tax benefits that could negatively impact your finances. We encourage you to contact us to start planning now – there may be some steps (as mentioned below) you can take immediately to soften the impact on your bottom line.
We have come to the edge of a “fiscal cliff,” as it is being called, because of several events that will have an impact all at once:
  • Tax cuts enacted during the Bush Administration are set to expire at year-end.
  • A new 3.8% Medicare surtax on some investment income will become effective Jan. 1, 2013.
  • A 2% reduction in the payroll taxes that fund Social Security expires on Dec. 31, 2012.
  • Changes to some itemized deductions could increase the rate on ordinary income to an effective rate that is as much as 44.6% for some taxpayers.
  • A possible increase on long-term capital gains could push rates from 15% to 20% and the rate on qualified dividends could jump to an effective 44.6% from 15% today.
  • A rise in the estate tax rate to 55% from 35% and a cut in the exclusion amount for what is subject to estate taxes to $1 million from $5.12 million.
  • A reduction in the Alternative Minimum Tax Exemption will impact tens of millions of taxpayers.
  • Potential across-the-board budget cuts in both defense and non-defense spending.
We recommend that clients take a two-pronged approach that involves addressing many of the possible changes directly while also making use of all options for deductions and credits, or other tax-advantaged opportunities to lower their taxable income. Planning for these changes should begin now, since it may involve significant modifications in your tax strategy.  
Prepare for the Worst Case Scenario – Reduce Your Liability
In light of the looming potential tax law changes, you may want to consider the following:
  • Many investors have included dividend paying stocks along with taxable bonds to maximize returns in recent years. However, as capital gains rates might increase as well as income tax rates, a different mix of investments might need to be considered.
  • If your portfolio includes significant long-term capital gains, should you take advantage of the lower rates in 2012?
  • You may want to move into tax deferred or federally non-taxable investments like municipal bonds.
  • Lowering your net investment income or modified adjusted gross income if you may be subject to the 3.8% surtax on certain passive income of individuals, trusts and estates.
  • If you have been considering gifting to family members, move ahead with these strategies now to avoid the confusion from the estate tax issues. If you’d like the beneficiaries of your will to avoid a possible spike in estate tax, you can give them up to $13,000 a year tax free right now. Sharing the wealth now may also make it possible to reduce the value of your overall estate so that little or none of it is subject to estate taxes when your beneficiaries inherit it.
  • Accelerate ordinary income into 2012. If you have flexibility on when you can receive payments of income before year end, consider that they may be subject to lower taxes than in 2013. Another option may be to convert a traditional IRA to a Roth IRA this year, if a conversion otherwise makes sense. Or reverse a conversion if it has not benefited your IRA accounts to have made the conversion.
  •  Defer expenses into 2013, but take care not to violate accounting method rules.
  • Arrange to make large charitable contributions directly from your IRA, saving taxes for years.
  • Delay some contributions. If you always make year-end donations to favorite charities, consider putting them off until January 2013 so they can offset the higher tax rates that may come into play then (with consideration for possible deduction phaseouts). If you have securities that have appreciated in value, consider donating them to charities to avoid potential new taxes on dividends.   
Take Sound Tax Planning Steps
Some of our recommendations are always good items to check off your year-end tax planning checklist. They include:
  • Make the greatest possible contribution to your 401(k) or other employer-based retirement plan. A contribution of pretax income to a plan not only lowers your taxable income, but also it may be eligible for a matching contribution from your employer to your retirement account. You can enhance your retirement income by contributing enough to receive the maximum match offered.
  • Do not leave your 401(k) investments on auto pilot – – review the investment mix to determine if you are maximizing value here.
  •  Set up or contribute to a 529 college savings plan. Your earnings on these accounts grow tax free as long as they are ultimately used for qualified education expenses.
  • In many states, taxpayers are required to pay a use tax on Internet purchases when the seller did not collect sales tax on that purchase. This is a good time to determine whether you might be subject to a use tax so that it’s not a surprise later.
  • Determine if you must begin taking a required minimum distribution from a retirement account. Taxpayers generally must begin taking them during the year in which they reach 70½ (although the first year’s payment may be delayed until April 1 of the following year).
  • For 2012, take advantage of the ability to make charitable contributions from your IRA if you have excess retirement savings.
  • Wherever possible, use valuable credits, such as the American Opportunity Credit, which can be used for the first four years of college. For eligible taxpayers, it is a dollar-for-dollar reduction of taxes owed. If your tax bill is going to rise, such credits will become even more valuable. 
We can help you understand the effect these possible increases could have on your tax situation and create strategies to minimize the impact. Please don’t hesitate to contact us today to discuss your options and how these strategies may help you. 
Written by Michael Musson, Partner, CPA LinkedIn Profile


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