Looming Tax Changes Create Uncertainty in Tax Planning Strategies... and also Opportunities

June 16, 2012
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Congress passed the initial “Bush tax cuts” more than 10 years ago. Designed to be temporary (only through 2010), the cuts still impact virtually every taxpayer today, including individuals, businesses, exempt organizations, and others. In 2010, Congress could not agree on whether to make the cuts permanent. Instead, they extended the cuts for two more years through 2012. 

Now, as Election Day looms and the expiration date moves closer, any hope for a quick resolution is doubtful. In the meantime, taxpayers are left with many questions about tax planning strategies for 2012 and beyond. A laundry list of tax incentives will expire after 2012 unless Congress acts. While some incentives (e.g., reduced individual tax rate brackets and preferential rates for long-term capital gains and most dividends) receive much attention in the media, others do not. 

This Tax Alert highlights some of the tax cuts scheduled to expire after 2012 and what will happen if they actually expire. Wipfli can help you proactively plan for this uncertainty and ensure that you are not left in the dark when changes (intended or unintended) ultimately occur. In the coming weeks and months, we will continue to update you on expected changes and specific strategies to combat the threat of higher overall taxes.

Individual Tax Rates

Unless extended, the current individual marginal income tax brackets for ALL taxpayers will expire and increase as follows: 

Current 2012 Rates 2013 Rates - If Law Expires
10% 15%
15% 15%
25% 28%
28% 31%
33% 36%
35% 39.6%
In addition to these substantial increases, the 2010 Health Care Act imposes a 3.8% surtax starting in 2013 on so-called “unearned income.” These increases apply generally to individual taxpayers earning over $200,000 and married couples who file jointly earning over $250,000. These increases are in addition to the increases listed above. Thus, your top tax rate could be as high as 43.4%. In Wisconsin and Minnesota, the combined overall rate could well exceed 50% in 2013. Later this month, we may receive news from the Supreme Court on whether all or some of the Health Care Act will be repealed. 

Both President Obama and the GOP have indicated their opposition to allowing the rates to revert for middle-income taxpayers after 2012. However, the White House and the GOP differ sharply on whether to extend the top two current rates (33% and 35%) or not. At this time, it is highly unlikely that the White House and the GOP will reach an agreement before the November elections. The fate of the rate cuts may be left to the lame-duck Congress that will meet after the elections. Recently, there has been talk of Congress passing a short-term extension (six months) of the rate cuts and punting the fate of the cuts (and many of the incentives discussed below) to 2013. The current federal debt, deficit, and spending issues also go hand-in-hand with any discussion of proposed tax changes, which makes any resolution unlikely this year.

Alternative Minimum Tax (AMT)

For many taxpayers, the AMT is effectively their regular tax because of a combination of factors (such as living in an area with high state/local taxes and high home values). To prevent the AMT from encroaching on middle-income taxpayers, Congress has routinely “patched” the AMT. The patch provides higher exemption amounts along with other targeted relief. The most recent patch in the 2010 Tax Relief Act expired at the end of 2011. 

President Obama and some Republicans have proposed to repeal the AMT. They differ—strongly—on what would replace it. The President has proposed the so-called “Buffett Rule,” which would ensure that taxpayers making over $1 million annually would pay an effective tax rate of at least 30%. House Republicans have proposed to eliminate the AMT, along with consolidating the individual tax rates from six to two. The most likely outcome is another patch for 2012, followed by a more permanent solution found within broader efforts toward “tax reform” in general.

Capital Gains and Dividends

Preferential rates on qualified capital gains and dividends are also scheduled to expire after 2012. Under current law, the maximum tax rate on qualified capital gains and dividends is 15% (0% for taxpayers in the 10% and 15% income tax brackets). After 2012, the maximum capital gains tax rate is scheduled to revert to 20% (10% for taxpayers in the 15% bracket), and dividends will be taxed at the ordinary income tax rates (potentially up to 39.6%). 

As with the individual rate cuts, the White House and the Republicans are far apart on the fate of the capital gains/dividends rate cuts. Some taxpayers are accelerating capital gains into 2012 while the tax rates are lower as one strategy to deal with the uncertainty.

Federal Estate Tax

No provision in the Tax Code has been subject to more uncertainty (and debate) in recent years than the federal estate tax. The Bush tax cuts reduced and ultimately repealed (sort of) the tax in 2010. The 2010 Tax Relief Act made significant changes, providing for a maximum estate tax rate of 35% for decedents dying after December 31, 2009, and before January 1, 2013, and an applicable exclusion amount of $5 million ($5.12 million in 2012 after an adjustment for inflation). In addition, estates of decedents dying after December 31, 2009, and before January 1, 2011, had the option to elect not to apply the basic estate tax regime under the 2010 Tax Relief Act (i.e., tax repealed for some). The complex 2010 rules are scheduled to expire after December 31, 2012. Under current law, the federal estate tax is scheduled to revert to a maximum tax rate of 55% with a $1 million exclusion amount after 2012. In other words, the number of people subject to the tax will increase dramatically (estates of $5 million in 2012 versus $1 million in 2013).

Along with the federal estate tax, many taxpayer-friendly changes to the federal gift tax and the generation-skipping transfer (GST) tax are scheduled to expire after 2012. Please contact our office for more details about the federal gift and GST taxes. As with other changes, the White House and the GOP are at odds on the fate of these transfer taxes (estate, gift, and GST), and any change will likely not occur until after the election at the earliest. 

Child Tax Credit

The $1,000 child tax credit for dependents under age 17 could be cut to $500 after 2012 if the scheduled reduction takes place. In addition, the 2010 Tax Relief extended other enhancements to the credit, which also are scheduled to expire after 2012. The likelihood of Congress extending the $1,000 child tax credit is high; the question is when. Individuals will claim the credit on their 2012 returns filed in 2013, which gives lawmakers some time to extend the credit without taxpayers being adversely affected.

Other Expiring Incentives

A lengthy list of tax cuts in the 2010 Tax Relief Act are scheduled to expire after 2012. They include (and this is not an exhaustive list):

  • Marriage penalty relief
  • Repeal of the limitation on itemized deductions for higher-income taxpayers
  • Repeal of the limitation on personal exemptions for higher-income taxpayers
  • Enhanced child and dependent care credit
  • Repeal of 60-month restriction on student loan interest deduction
  • Enhanced Coverdell Education Savings Accounts
  • Special rules for certain tax-exempt bonds
  • Repeal of the state death tax credit
  • Enhanced adoption credit and adoption assistance programs
Along with all of these, Congress must decide the fate of the so-called “extenders.” These are popular but temporary tax incentives, many of which expired after 2011. They include the research tax credit, the optional state and local sales tax deduction, and many more. The lame-duck Congress may also decide the fate of the employee-side payroll tax cut, which is also scheduled to expire 
after 2012.

Planning challenges

Uncertainty is always a factor in tax planning. Life brings countless changes, such as an increase or reduction in income, birth of a child, death of a spouse, and so on. In 2012, uncertainty is magnified by the unknown fate of countless tax provisions on which taxpayers have relied in recent years. The uncertainty is expected to continue until after the 2012 election, and maybe even into 2013. 

Wipfli can help you plan for all of this uncertainty by adopting strategies that allow you to remain flexible for as long as possible while being prepared to act on opportunities before they are lost to time and changing laws. 

Making plans now to accelerate certain income, defer specific deductions, recognize capital gains, and take advantage of current gift and estate tax rules are only some of the strategies that may fit your situation. 

Please contact your Wipfli relationship executive to discuss your tax planning in more detail.

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