Year-end Tax Planning-2012

This is more or less the 40th year in which people have asked my advice about year-end tax planning, and it's safe to say that none of those years have presented as many uncertainties. Here's the situation as of the first week in December. Unless Congress acts in the next couple of weeks, federal taxes will increase in 2013. The historic approach to this kind of tax situation has been to encourage taxpayers (to the extent possible) (1) to accelerate income into the "low tax" year (2012) and (2) to defer deductions into the "high tax" year (2013), where they should be more valuable. This may or may not be good advice this time around.

Why? First of all, we don't really know what the rules are:

  • Although federal taxes are expected to increase in 2013, we don't know what combination of rate changes, deduction limitations, and changes to other rules (such as the special tax rates on capital gains and dividends) will produce that result. Different mixes could have dramatically different impacts on different taxpayers or different transactions.
  • It could be a long time before the 2013 tax laws are nailed down. Although optimists hope the 2013 tax laws will be put in place in definitive form before the end of 2012, Congress can enact tax legislation as late as December 31 of next year that would be retroactively effective January 1, 2013.
  • Somewhat surprisingly, we can't yet even be sure what the 2012 tax laws are. Apart from the big 2013 issues that have attracted so much public discussion, there are a host of far-from-trivial parts of the Internal Revenue Code that Congress has yet to deal with for the current tax year. The most important open item is the annual "fix" of the alternative minimum tax ("AMT"), which affects a large and growing number of taxpayers and can significantly affect the income tax value of charitable contributions and other deductions. (Actions which result in lower "regular" income tax can be largely offset by increases in AMT.) But it could be very late this year before those provisions are dealt with.*

So to a greater or lesser extent, we are all flying blind. Both this year and next, we will almost certainly have to make decisions about tax-related transactions without knowing exactly what the impact will be on our federal tax bill. An increasing number of pundits seem to be suggesting that taxpayers might just as well relax and let whatever happens happen. I'm not sure I would go that far, but I would suggest that the extraordinary degree of uncertainty at this time means that this may not be the best year in which to engage in transactions that involve big bets on how the law will settle out.

Given the fluidity of the situation, what can a thoughtful taxpayer do in order to produce reasonably satisfactory bottom-line results? A couple of thoughts come to mind:

  • Keep up with the news. Some of the uncertainties may be resolved by the folks in Washington in sufficient time to take action based on more complete knowledge about what the applicable law is (or will be).
  • If you don't itemize deductions (and 70% of American taxpayers do not), your situation is a lot easier to deal with. Many of the "revenue enhancement" proposals now flying around Washington involve limitations on itemized deductions rather than tax rate increases, and changes of that sort won't affect you if you don't itemize.
  • If you're subject to AMT, your situation is a lot harder to deal with, and it's almost essential that you do your planning in consultation with a skilled tax advisor and run some numbers. AMT exposure is a particular issue for taxpayers with large state and local tax deductions, long-term capital gains, income from the exercise of stock options, or a large number of dependents. The degree of exposure depends to a large extent on annual decisions by Congress on how much income is exempted from AMT - a decision, as noted above, that has not yet been made for 2012, let alone 2013.
  • Don't assume that charitable contributions or other deductions will save you more money in 2013 than they would this year. Deductions may end up providing fewer tax benefits next year than in 2012. The main reasons for this: (1) A couple of old limits on itemized deductions were temporarily made inapplicable in 2012, but are scheduled to return in 2013. (2) Both the Obama administration and at least some Congressional members of both parties have proposed significant new limits on itemized deductions, as a way of raising revenue without raising tax rates.
  • Almost every pundit says that taxes on investment income (dividends and capital gains, mainly) will never again be as low as they are in 2012. This is probably the safest bet in terms of predicting the eventual outcome of negotiations about taxes, so accelerating capital gains (and, if you can control them, dividends) into 2012 may make sense. (But note my earlier warnings about AMT surprises and the risks of any kind of big bet. And remember that capital gains tax is awfully easy to avoid: through charitable gifts of appreciated property, for example; through offsetting losses; or through the basis step-up all taxpayers receive at death.) The most important advice I can give is that every taxpayer's situation is different, and that there are no "one size fits all" generalizations about taxes, particularly this year. And as the foregoing proves, this stuff is complicated. To have the best chance of optimizing your results - or of avoiding major blunders - it's important to run numbers based on your family's particular circumstances, ideally with the help of a seasoned tax professional.

Feel free to contact me or our Senior Director of Planned Giving, Chuck Miller, to discuss how to further your charitable goals. My contact information is available here. Chuck can be reached at 216.368.8640 or cmm38@case.edu.

* A number of tax laws relating to charitable giving expired at the end of 2011, and those of us in the fundraising business hope that they may yet be restored for 2012 when the AMT fix is made or the customary "extenders" tax bill is enacted. For individuals, the most important of the expired provisions is the "IRA charitable rollover," which allowed those 70-1/2 or older to make charitable gifts directly from an individual retirement account.