President Obama's re-election signals the likelihood of up-coming difficult negotiations between Democrats and Republicans over (1) the fate of the Bush-era tax cuts, (2) nearly $100 billion in automatic spending cuts for the Government's fiscal year beginning October 1, 2013, and (3) whether a long list of recently enacted, but now expiring tax benefits and exclusions, including the AMT patch for 2012 and beyond, will be extended again. Despite the present level of uncertainty over what is ahead, the one thing that is fairly certain is that year-end tax strategies for 2012 will demand more than normal attention from "higher income" taxpayers and will involve more than the traditional year-end planning advice to defer income from, and accelerate deductions into, the current year.
Q: What are some of the more immediate concerns facing "higher-income" taxpayers for 2012?
A: President Obama has repeatedly called for higher tax rates on single taxpayers with annual incomes above $200,000 and married filing jointly taxpayers with annual incomes above $250,000 (oftentimes referred to by the President as the "wealthy"), while continuing the Bush-era tax rates for all others. He can accomplish the former by ensuring that the Bush-era tax cuts do in fact expire on December 31, 2012 as they are now scheduled to do without any further Congressional action. Extending the Bush-era tax cuts to the non-wealthy would, however, require Congressional action. If the President gets his way, then we can expect the following:
His re-election also ensures that the 3.8% "Medicare contribution" tax on the "net investment income" (which is very broadly defined)1 of the wealthy will go into effect on January 1, 2013.
It should also be noted that unless Congress takes action to extend the 2% payroll tax holiday which has been in effect for 2011 and 2012, commencing January 1, 2013 the employee's portion of FICA taxes will return to its pre-2011 level of 6.2% of wages. And, in addition, the taxable wage base for FICA taxes will increase from $110,100 to $113,700 for 2013.
Q: Is there any chance that Congress will simply extend the Bush-era tax cuts for another year while using 2013 to arrive at a "grand bargain" that permanently resolves the fate of the Bush-era tax cuts, fundamentally reforms the corporate tax code, and takes a serious step toward deficit reduction?
A: There is always a chance that such a scenario will play out, but President Obama is on record as not favoring such an approach. Many think that due to Congressional gridlock, Congress will take no action before January 1, 2013, the Bush-era tax cuts will expire for everyone, and sometime in early 2013, the Democrats will propose legislation reinstating the Bush-era tax cuts for the non-wealthy thinking that the Republicans cannot afford to not go along with that approach.
Q: If we assume that the Bush-era tax cuts in fact expire on December 31, 2012, what are some key tax-planning opportunities that higher income taxpayers should take advantage of prior to January 1, 2013?
A: Actually, there are several actions that are of special relevance to higher income taxpayers that they should consider taking before year-end, including some of the following approaches that seem to violate the traditional advice of deferring income and bunching expenses in the current year:
Q: Other than the new 3.8% Medicare Contribution tax and the new 0.9% Medicare payroll tax that first become effective in 2013 under ObamaCare, are there any other tax surprises for 2013 under ObamaCare?
A: There are two other fairly significant tax provision found in ObamaCare that take effect in 2013.
Q: I keep hearing about ObamaCare's "pay or play" tax penalty that is supposed to take effect in 2014. Will that affect me personally?
A: Not directly. The so-called "pay or play" tax which is provided under Section 4980H of the Internal Revenue Code potentially applies to employers with an average of at least 50 "full-time" and "full-time equivalent" employees. Generally, the tax only kicks in whenever the employer either (i) does not provide a health plan for its employees (sometimes referred to as the "sledgehammer tax"), or (ii) provides a health plan that requires too large a required contribution by the employees (sometimes referred to as the "tack hammer tax"). These taxes will apply if at least one of the employees qualifies for a "premium assistance tax credit" from the IRS and obtains his or her own health insurance under one of the State or Federal Health Exchanges mandated by ObamaCare (referred to herein as "eligible employees"). The tax under IRC Section 4980H can be quite significant. The sledgehammer tax is equal to the product of (a) $2,000, times (b) the total number of the employer's full-time employees less 30. The tack hammer tax is equal to the product of (a) $3,000, times (b) the number of eligible employees, but in no event can the tack hammer tax ever exceed the amount of the sledgehammer tax if it would have otherwise applied to the employer. In addition, the tax is nondeductible to the employer. Employers subject to these rules will have a decision to make on whether to pay the additional taxes or continue to sponsor their health insurance plans for their employees.
1 For purposes of this 3.8% tax, the term "net investment income" includes interest, dividends, annuities, royalties, rents, "recognized" capital gains, and even "passive activity" income from trade or business activities of the taxpayer. Accordingly, this tax will potentially apply to any capital gain recognized by a wealthy taxpayer upon the sale of his personal residence, but only to the extent that the gain is greater than the applicable tax free threshold amount ($500,000 for married filing jointly taxpayers, $250,000 for all other taxpayers).
2 For 2013-2016, the AGI floor remains at 7.5% of AGI for taxpayers who have attained age 65.
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