Corporate CPAs must be ready for the tax fiend called ‘2013’
Aug 15, 2012
By David A. Krebs, CPA
Corporate CPAs must hope for the best and plan for the worst when it comes to tax planning at the end of 2012.
On June 28, the Supreme Court upheld the Patient Protection and Affordable Care Act (PPACA), with a 5-4 vote. The surprising part of PPACA is the sheer number of tax provisions the voluminous document contains.
A major unknown still remains. Tax rates are scheduled to increase dramatically in 2013 unless Democrats and Republicans in the House and Senate can agree on extending the Bush tax cuts during an election year. Additionally, the president (whoever it happens to be at the time) must approve the legislation.
The “Relief Reconciliation Act of 2001” and the “Jobs Growth Tax Relief Reconciliation Act of 2003” – popularly referred to as the “Bush Tax Cuts” – reduced individual income and estate tax rates in a variety of ways from 2001 to 2010. The tax cuts were extended for 2011 and 2012 by the “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.” The article will refer to all these cuts as the “Bush Tax Cuts.” It should also be noted that the extension was passed under President Obama not President Bush.
The Bush Tax Cuts lowered income tax rates in several ways. Let’s review a chart for married filing joint taxpayers comparing differences in tax brackets, the standard deduction and personal exemptions between 2012 (with Bush Tax Cuts) and 2013 (without Bush Tax Cuts), as shown on chart A.
Source: Tax Policy Center and the IRS
As you can see from the chart below, the 10% tax bracket disappears in 2013
and certain income levels taxed at 15%, 25%, 28%, 33% and 35% in 2012 will be taxed at higher 28%, 31%, 36% and 39.6% rates in 2013. Married taxpayers will also lose the doubling of the brackets for the standard deduction and the 15% brackets. Even though the personal exemption doesn’t change, it can still be reduced if the taxpayer has certain income levels starting in 2013. Itemized deductions would fall under the same type of rules. The qualifying dividends and long-term capital gain rates are also scheduled to change as shown on chart B.
Have I got your attention yet? I’m not done. The 2% reduction in the social security withholding rate for employees and the self-employed is set to expire at the end of 2012.
As mentioned earlier, now that PPACA is official, we will need to add in the additional costs with that starting in 2013 for high income taxpayers. There will be an additional 3.8% Medicare tax on all or part of their net investment income which would include dividends and long-term capital gains. High income taxpayers will also be hit with an additional .9% Medicare tax on their wages. The high income taxpayer is generally defined as one having a modified adjusted gross income of $250,000 if married and $200,000 if unmarried.
The final piece of the puzzle is the loss of many popular tax provisions if they are
not extended. There are many provisions from 2011 that haven’t been extended.
On the business chopping block at the end of this year are items such as
50% bonus depreciation as well as the increased Section 179 depreciation limit of $125,000 on a threshold of $500,000 of assets purchased. This was reduced from the 100% bonus depreciation and $500,000 Section 179 depreciation limit on a $2,000,000 threshold in 2011. To see a complete list of expiring provisions in 2011 and 2012 go to https://www.jct.gov/publications.html?func=startdown&id=4383.
Let’s do some simple math for taxpayers in the highest bracket (often the owners of corporate businesses). Ordinary income tax could increase from 35% to 39.6% plus 3.8%, or a 24% increase. Long-term capital gain tax could increase from 15% to 20% plus 3.8%, or a 59% increase.
We now know the 3.8% Medicare tax will be effective in 2013. We will have to wait and see on the rest. What does this mean from a planning standpoint? We could be doing the exact opposite of what we have done for 12 years in a row. When taxable income and brackets are steady, tax strategy would say to accelerate deductions and defer income. The end of 2012 is telling us to consider accelerating income into 2012 and deferring expenses into 2013 or later (higher tax rate years).
The year 2012 may also be the perfect time to sell appreciated assets, such as personal stocks or the business assets or stock. Even if you sell assets on the installment basis, you can make an election to report all the gain in 2012.
C Corporations find themselves in a particularly interesting time. 2012 could be the perfect time to pay out dividends which are subject to a 0% percent tax rate in 2012 if the shareholder is in a 15% or lower tax bracket after adding in the dividend. If the shareholder is in a higher than 15% bracket, the tax will be no more than 15% which is much better than 2013.
The other C Corporation decision is to consider whether they should be a C Corporation any more. If C Corporation dividends and asset sales end up being taxed as ordinary income in the future, it will have a dramatic impact on profits to be left in the C Corporation because of the double tax nature. A C Corporation is taxed on the profits left in the business and then is taxed again when the profits are distributed or when the business is sold. The C Corporation may wish to make an S election starting in 2013 or simply liquidate when they have minimal fair market value.
As you can see, 2012 is a very interesting year for tax purposes. We know taxes are increasing for high income taxpayers due to the Supreme Court ruling on Health Care Reform. It’s possible we will get a tax extension on some or all of the other provisions we discussed. Nevertheless, you need to plan for a perfect storm of tax increases. You will then be ready to maneuver before the tax fiend called 2013 arrives.
David A. Krebs, CPA is the chief visionary officer of the CPA Advisory Group and managing member of Envision Financial Services, LLC. He has led a multi-divisional accounting, tax, financial services and education firm in Columbus for over 25 years, and is a sought-after presenter on taxation, small business, practice development and financial planning for Thomson Reuter’s Gear Up Seminars and independently.