a 3.8% surtax on the lesser of net investment income (NII) ... (NII) includes interest, dividends, annuities, royalties,
2012 TAX STRATEGIES FOR BUSINESS OWNERS AND CORPORATE EXECUTIVES
Without action by Congress, the tax landscape in America will transform significantly in 2013. There are numerous changes slated for year-end, including: scheduled budget cuts resulting from last year’s debt ceiling negotiations; the expiration of the Bush-era tax cuts on income and investment gains; the reduction of the lifetime gift and estate tax exemption limits; and the implementation of new Medicare taxes created by recent healthcare reform. This so-called “fiscal cliff” is anticipated to be a drag on economic growth and result in a higher tax bill for many Americans in 2013 and future years. This could be especially true for business owners and corporate executives who could be particularly impacted by these changes. The timing of these changes makes today’s favorable tax environment potentially all the more advantageous for positioning your wealth for the future. The key is to assess your options as soon as possible so you can take advantage in case the lower rates expire. As it is highly unlikely that there will be any changes in tax legislation before this year’s elections, this is an important time to consult with your financial and tax advisors to evaluate different scenarios and help position your finances to keep the potential tax impact to a minimum. As the situation stands, you’ll face higher income, capital gains and dividend taxes and possibly two new Medicare taxes in 2013. The new Medicare taxes include an additional 0.9% on wages or self-employment income over $200,000 if single and $250,000 if married filing jointly; and a 3.8% surtax on the lesser of net investment income (NII)
or excess modified adjusted gross income (MAGI) over $200,000 if single and $250,000 if married and filing jointly. The table below highlights scheduled income tax changes if the Bush-era tax cuts expire after December 31, 2012. SCHEDULED INCOME TAX RATE CHANGES
Married filing jointly
2012
2013
Up to $8,700
Up to $17,400
10%
15%
$8,701 - $35,350
$17,401 - $70,700
15%
15%
Single
$35,351 - $85,650
$70,701 - $142,700
25%
28%
$85,651 - $178,650
$142,701 - $217,450
28%
31%
$178,651 - $388,350
$217,451 - $388,350
33%
36%
Over $388,350
Over $388,350
35%
39.6%
The tax expiration also will result in the maximum longterm capital gains tax increasing from 15% to 20% and the 15% tax rate on qualified dividends increasing to ordinary income rates.
TAX STRATEGIES There are a number of tax-saving strategies for business owners and corporate executives to consider now in efforts to capitalize on the lower 2012 tax environment as well as minimize taxes in 2013 and beyond. ACCELERATING INCOME With respect to the higher capital gains tax and the added Medicare surtax, consider selling off highly
DID YOU KNOW Net investment income (NII) includes interest, dividends, annuities, royalties, rental income, passive activity income and capital gains from the sale of property less allowable expense deductions like advisory fees and commissions. Note that NII does not include tax-exempt bond income, IRA or qualified retirement plan distributions, self-employment income, income from an active trade or business, or gain on the sale of an active interest in a partnership or S corporation.
2012 TAX STRATEGIES FOR BUSINESS OWNERS AND CORPORATE EXECUTIVES
appreciated stock in 2012 in order to pay less in taxes now rather than holding for the longer term. Alternatively, If you have unrealized investment losses, you may want to wait and sell them in 2013 to offset higher taxes on next year’s return. 2012 is also a good time to exercise vested, in-the-money, non-qualified stock options. Converting to a Roth IRA in 2012 can also help you avoid the 3.8% Medicare tax on distributions taken after 2012.* Traditional IRA required minimum distributions (RMDs) drive up MAGI, which may cause NII to be exposed to the 3.8% Medicare tax. Roth IRA distributions are not included in MAGI. Any amount converted, to the extent taxable, is ordinary income in the conversion year. For those individuals operating a business as selfemployed with a Schedule C, be sure to maximize your accounts receivable collections in 2012 as much as possible and use the cash accounting method to maximize income in the current year when taxes are lower. If possible, it is also recommended to take bonuses or dividends in 2012 rather than 2013. SELLING A BUSINESS OR OTHER LARGE ASSET As a business owner, if you plan to sell a business or a significant asset holding in 2013, consider establishing a charitable trust and transferring shares into the trust pre-sale to reduce capital gains exposure and to receive an income tax deduction. Proceeds from assets sold inside a charitable remainder trust, or CRT, may be reinvested without exposure to capital gains tax or the anticipated 3.8% Medicare surtax associated with net investment income over the defined threshold. On the other hand, CRT distributions made to the grantor would be included in MAGI and may trigger the 3.8% Medicare surtax. Pending changes for 2013 also include a reduction in the allowable gift exemption on your estate. As it stands,
the lifetime gift exemption will decline from $5,120,000 to $1,000,000 per person (or $10,240,000 to $2,000,000 for couples). To reduce taxes on your estate in the future, it is a wise choice to take advantage of the significantly higher lifetime gift exemption today. In doing so, gift as much cash, stocks and property – as appropriate for your individual situation – to children and grandchildren this year. The charitable deduction cap is also anticipated to decline, so if there is a particular charity of interest, consider maximizing a donation in 2012. This will also help offset taxes in 2012 related to any accelerated income choices you may make. QUALIFIED RETIREMENT PLANS Contributions to qualified retirement plans are more valuable and effective in a higher tax rate environment. If you are an owner or employee of an S corporation with no other employees, establishing and participating in a defined plan in 2013 will help reduce the impact of higher tax rates. Alternatively, to enhance your wealth position in 2012 and reduce future taxes, take larger distributions from IRAs and qualified plans, if not subject to early withdrawal penalties. WORK WITH YOUR FINANCIAL AND TAX ADVISORS There are certainly a number of tax strategies to consider for protecting your wealth in light of pending tax changes. It is wise, however, not to make changes to your financial plan based on tax considerations alone. Establishing your personal goals for both the short and long term is most critical. Tax strategies can be used to help you achieve these goals and should be utilized within the context of your overall financial picture. Your financial advisor and tax professional can help you review how today’s tax environment and pending changes may impact your personal situation, and they can help identify tax strategies that may be advantageous in 2012 and 2013.
* Rolling from a traditional IRA into a Roth IRA may involve additional taxation. When converted to a Roth, the client pays federal income taxes on the converted amount, but no further taxes in the future. Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount is subject to its own five-year holding period.
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