2012 Year End Tax Planning

CCH Tax Briefing

2012 Year-End Tax Planning
October 4, 2012 Special Report

Highlights
Tax/Budget Uncertainties Impact
Possible Hikes In Individual
2012 Year-End Strategies

Y
Tax Rates
ear-end tax planning is always compli- the tax rates – a major driver of year-end
cated by the uncertainty that the fol- strategies – will not get any lower than they
3.8% Medicare Surtax On lowing year may bring and 2012 is no are right now. Effectively, the choice may
Net Investment Income exception. Indeed, year-end tax planning in come down to paying the tax now or later.
2012 is one of the most challenging in recent
Reduced Dividend Rate memory. A combination of events – includ- Comment. Democrats and Republicans
In Jeopardy ing possible expiration of some or all of the appear to be taking a wait-and-see ap-
Bush-era tax cuts after 2012, the imposition proach to deciding the fate of the expir-
Techniques To Reset Basis of new so-called Medicare taxes on investing tax provisions and the spending cuts
ments and wages, doubts about renewal of until after Election Day. Alternatively,
many tax extenders, and the threat of mas- the lame-duck Congress could punt the
Over 40 Expiring Extenders sive across-the-board federal spending cuts tax provisions to the new Congress that
– have many taxpayers asking how can they will meet in January 2013. To compli-
Post-Election Triggers prepare for 2013 and beyond … and what cate matters, the Budget Control Act of
to do before then. The short answer is to 2011 imposes across-the-board spending
Eleventh-Hour Strategies quickly become familiar with the expiring tax cuts (called “sequestration”) after 2012.
incentives and what may replace them after To avert the spending cuts, lawmakers
2012 … and to plan accordingly. Year-end must make up revenue somewhere else.
planning for 2012 requires a combination of User fees and other “non-tax” revenues
multi-layered strategies, taking into account can only go so far. Tax incentives, espe-
INSIDE a variety of possible scenarios and outcomes. cially for higher-income individuals and
businesses, may be on the chopping block
Income Tax Rates.................................... 2 This Tax Briefing covers year-end tax plan- before year-end.
Capital Gains/Dividends....................... 2 ning considerations that are especially
unique to 2012. Its focus is on aligning tra-
3.8 Percent Medicare Tax...................... 4 ditional year-end techniques with strategies INDIVIDUAL PLANNING
for dealing with those uncertainties created
0.9 Percent Medicare Tax...................... 6 by Congress’s delay in addressing sunsetting Year-end tax planning for 2012 is compli-
Alternative Minimum Tax..................... 7 tax rates and the extension of other major cated by several unique factors connected to
tax benefits. Year-end strategies in response tax rates:
Education................................................. 8 to the new-for-2013 3.8 percent Medicare
contribution tax are also a focal point of this First, planning must account for the pos-
Estate/Gift Tax.......................................11 Tax Briefing. sibility of the expiring Bush-era income
Business Planning................................. 12 tax rates to move in one of four directions:
STRATEGY. Fence-sitting for some year- (1) complete sunset for all taxpayers, (2)
Health Care ........................................... 15 end strategies may not be possible in De- complete extension for all taxpayers, (3)
cember, or earlier, because of the time it sunset for higher-income individuals
takes transactions to be set into motion. only, or (4) sunset for millionaires only.
Other strategies can be held at the ready Second, the same four scenarios must
with trigger dates, but not executed until be considered in connection with sun-
more is known about how Washington setting Bush-era rates on capital gains
will act. Chances are good, however, that and dividends.
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2

Third, investors in the higher tax brack- $125,000 for married taxpayers filing sepa- 2003 rates of 10 percent for taxpayers in
ets must plan for the 3.8 percent Medi- rately. If those income levels – which are the 15 percent bracket and a maximum 20
care contribution tax on investment in- proposed to start at adjusted gross income percent rate for all others. Dividends will
come that starts in 2013. rather than taxable income – are also indexed be subject to the ordinary income tax rates.
Fourth, high-income wage earners must for inflation since 2009, the levels would rise The maximum rate on five-year property
also contend with a 0.9 percent addi- to $213,200 / $266,500 / $239,850 / and will be 18 percent (8 percent for those in
tional Medicare tax that starts in 2013. $133,250, respectively, for 2013. the 15 percent bracket).
Fifth, the 2012 payroll tax holiday is
scheduled to expire after December Comment. Some lawmakers have dis- Comment. Capital assets yield short-
31, 2012, raising the employee-share cussed higher income thresholds. For ex- term gains or losses if the holding period
of Old Age, Survivors and Disability ample, the 39.6 percent rate would apply is one year or less, and long-term gains or
Insurance (OASDI) taxes from 4.2 per- only for individuals making more than losses if the holding period exceeds one year,
cent to 6.2 percent. $1 million. so that care must be taken in timing a sale.
The excess of net long-term gains over net
STRATEGY. As the Presidential elec- short-term losses is net capital gain. While
tion draws closer, there is more talk from “A combination of events short-term capital gains are taxed at ordi-
both sides about limiting deductions for nary rates, net long term capital gain of
higher-income taxpayers to offset the cost – including possible noncorporate taxpayers, as adjusted for
of other tax cuts, such as an extension of expiration of some or all certain types of long-term gain (adjusted
the reduced income tax rates. Gover- net capital gain), is eligible for lower max-
nor Romney has discussed a deduction of the Bush-era tax cuts imum tax rates than ordinary income.
“bucket” of $17,000 that taxpayers could after 2012, the imposition
fill with various deductions. President STRATEGY. Depending upon the appre-
Obama has continued to call for limiting of new so-called Medicare ciation or losses now locked into a cur-
deductions for higher-income taxpayers. taxes on investments rent portfolio, strategies to be considered
It is possible that 2012 could be the last include: (1) accelerate long-term capi-
year without significant changes to the and wages, doubts about tal gain, which has the certainty of be-
rules for deductions. renewal of many tax ing taxed at a 15 percent maximum in
2012 (or zero percent for those in the 10
extenders, and the threat or 15 percent income tax bracket), or (2)
INCOME TAX RATES of massive across-the- increase carryover losses into potentially
higher rates in years after 2012.
Nothing adds complexity to year-end 2012 board federal spending
tax planning as much as uncertainty over the cuts – have many STRATEGY. For those in control of C
fate of the Bush-era reductions to the indi- corporations, declaring special dividends
vidual income tax rates. The 2010 Tax Re- taxpayers asking how can to be distributed before 2013 may prove
lief Act extended through 2012 the reduced they prepare for 2013 and particularly fruitful if top rates on divi-
individual income tax rates in place since dends rise from 15 percent to 43.4 per-
2003 under the so-called Bush-era tax cuts. beyond … and what to do cent (39.6 percent plus the 3.8 percent
Unless extended, the reduced individual in- before then.” Medicare surtax).
come tax rates will disappear after 2012 to
be replaced by higher rates. The current 10, Liquidations. Corporate liquidations are
15, 25, 28, 33, and 35 percent rate structure on the uptick as some owners attempt to get
would be replaced by the higher pre-Bush taxed on distributions at the Bush-era rates
15, 28, 31, 36 and 39.6 percent levels. CAPITAL GAINS/DIVIDENDS before year end. The general timing rule that
applies requires each shareholder of a liqui-
As proposed by President Obama, the cur- Absent Congressional action, the tax rates dating corporation to recognize and report
rent rate structure would be retained, except on qualified capital gains and dividends gain or loss in accordance with his method
for revival of the 36 and 39.6-percent rates. are scheduled to increase significantly after of accounting.
The 36 percent rate, however, would start at 2012. The current taxpayer-favorable rates
a higher-income bracket level of $200,000 – zero percent for taxpayers in the 10 and STRATEGY. As 2013 approaches, it may
for single filers, $250,000 for joint fil- 15 percent brackets and 15 percent for all be valuable to consider tax loss harvesting
ers, $225,000 for head-of-households and other taxpayers – will be replaced by pre- strategies to offset current gains or to accu-

CCH Tax Briefing ©2012 CCH. All Rights Reserved.

October 4, 2012
3

mulate losses to offset future gains (which
may be taxed at a higher rate). The first Three Rate-Change Scenarios For 2013
consideration is to identify whether an
investment qualifies for either short-term
Complete Extension:
or long-term capital gains status, because
taxpayers must first balance short-term The existing rates for 2012 of 10%, 15%, 25%, 28%, 33% and 35% continue
gains with short-term losses and long- unchanged for 2013.
term gains with long-term losses. The
“wash sale rule” generally prohibits tax- Complete Sunset:
payers from claiming a tax-deductible loss If Congress fails to extend the Bush-era tax rates, the 2013 rates would change
on a security if they repurchase the same under the mandatory sunset provision based on the following schedule:
or a substantially identical asset within
30 days of the sale. Existing 2012 rate Sunset rate
10% and 15% 15%
Resetting basis. Wash sales are sales of stock
or securities in which losses are realized, but 25% 28%
not recognized, because the seller acquires 28% 31%
substantially identical stock or securities 30
33% 36%
days before or after the sale. Nonrecogni-
tion, however, applies only to losses; gains 35% 39.6%
are recognized in full.
Obama Proposal:
STRATEGY. Both a higher potential cap-
ital gains rate and the 3.8 percent Medi- The 2013 rates would change under President Obama’s plan released in February
care surtax (see, below) may be avoided 2012 (based on Joint Committee on Taxation projections):
by selling before year-end 2012 and then
immediately reinvesting. To buy back the Existing 2012 rate Obama rate proposal
same or substantially similar securities 10% and 15% 10% and 15%
both in kind and amount, of course, re-
25% 25%
quires an upfront cost in finding the cash
elsewhere to pay the tax or lowering the 28% 28%
amount reinvested. 33% 33% up to $200K ($250K joint returns),
inflation adjusted
To obtain long-term rates, investors must
hold the asset (such as stock and most other 33% 36% (above $200K/$250K joint returns)
property) for more than one year. The hold- 35% 39.6%
ing period begins on the day after the asset
is acquired and ends on the day the asset is
disposed of. Stock is generally treated as sold
on the trade date, the date the taxpayer enters sold the stock on December 1, 2012, the sells shares and then must obtain shares
into a contract to sell the stock. The trade taxpayer’s holding period is more than one to close out the transaction. If the stock
date should be distinguished from the settle- year, and gains (or losses) are long-term. price falls, so that the investor will realize
ment date, the date that the investor delivers a gain, the gain is realized on the trade
the stock certificate and receives payment. Example. A taxpayer bought stock on date, when the seller directs the broker to
The settlement date may be 3-5 days after the December 28, 2011 and sold it on De- purchase shares. If the price rises, so that
trade date. The trade date also determines cember 29, 2012. The settlement date is the investor will realize a loss, the loss is
(and ends) the holding period for the seller. January 3, 2013. The stock is treated as realized when the stock is delivered on the
sold on December 29, 2012; with any settlement date.
Example. A taxpayer bought stock on gains or losses recognized on the taxpayer’s
November 30, 2011 and sold it November 2012 return. Comment. In July, the House voted to ex-
30, 2012. The taxpayer’s holding period is tend the current capital gains and dividend
exactly one year, and any gain (or loss) is Caution. Different rules apply for a tax treatment through 2013. The Senate,
short-term. If the taxpayer instead had short sale, where the taxpayer initially however, voted to extend the current fa-

CCH Tax Briefing

4

vorable tax rates only for individuals with Comment. The application of the tax is some taxpayers to react quickly once regu-
incomes below $200,000 (families with still arguably uncertain because of continu- lations are released.
incomes below $250,000). For income in ing calls for full repeal of the Affordable
excess of $200,000/$250,000 the tax rate Care Act. But this is speculative. In the
on qualified capital gains and dividends meantime, the Supreme Court’s decision in
Specified Thresholds
would be 20 percent under the Senate bill. June 2012 upholding the Affordable Care Individuals. As stated above, the tax ap-
Act guarantees that the tax will take effect plies to an individual on the lesser of the
on January 1, 2013 and that the tax will taxpayer’s NII or the amount of “modified”
3.8 PERCENT MEDICARE not be repealed right away, if at all. adjusted gross income above certain thresh-
CONTRIBUTION TAX olds. Those AGI thresholds are:
STRATEGY. Since the Medicare surtax
One of the most important new areas of will not apply until 2013, taxpayers $250,000 for married taxpayers filing
concern for year-end tax planning in 2012 face several important planning decisions jointly or a surviving spouse;
is the 3.8 percent “unearned income Medi- while a window of opportunity still exists: $125,000 for married taxpayers filing
care contribution” tax on higher-income separately; and
individuals, estates and trusts. Taking ef- Whether to sell off assets and recognize $200,000 for single and head of house-
fect immediately on January 1, 2013, the gains in 2012, thus avoiding subjecting hold taxpayers.
Medicare surtax will be imposed on the tax- them to tax in 2013 (or later);
payer’s “net investment income” (NII) and How to reduce NII in 2013 and there- Caution. These threshold amounts are
will generally apply to passive income. The after; and not indexed for inflation.
Medicare surtax also will apply to capital How to reduce modified AGI in 2013
gains from the disposition of property. The and thereafter. Examples. (1) A single taxpayer has
Medicare surtax will not apply to income modified AGI of $230,000, including
derived from a trade or business, or from Taxpayers concerned about the Medicare NII of $40,000. The Medicare surtax ap-
the sale of property used in a trade or busi- surtax in most cases may want to realign plies to the lesser of NII ($40,000) or the
ness. For individuals, the Medicare surtax their investments and other income, or pos- excess of AGI over the applicable thresh-
will apply to the lesser of the taxpayer’s NII sibly sell certain assets, in 2012, before the old ($230,000 - $200,000 = $30,000).
or the amount of “modified” adjusted gross tax takes effect. While 3.8 percent alone may Thus, the Medicare surtax applies to
income (AGI with foreign income added appear to be only a few basis points above $30,000.
back) above a specified threshold. what would be a “nuisance tax,” its combina-
tion with ordinary income and capital gains (2) A single taxpayer has modified AGI
STRATEGY. Having a tax on NII is a rates makes planning worth serious consid- of $175,000, including $70,000 of NII.
“paradigm shift.” Traditionally, taxpayers eration. For example, short-term capital gain Because the taxpayer’s income is below the
want income to be passive, so that it is not tax rates may jump from 35 percent to 43.4 single taxpayer threshold of $200,000,
subject to employment taxes, and want percent (reflecting a combined rate of 39.6 the taxpayer does not owe the Medicare
losses to be nonpassive, so they can offset percent and 3.8 percent after 2012). surtax, despite having substantial NII.
other nonpassive income, such as wages.
With the new Medicare surtax on NII, Guidance pending. Before evaluating al- (3) Married taxpayers have modi-
taxpayers with higher incomes may want ternative year-end strategies, it is necessary fied AGI of $350,000, including NII
to demonstrate that income is from an ac- to understand how the Medicare surtax of $75,000 and file jointly. The Medi-
tive business, not a passive investment. works. While some issues are clear from the care surtax applies to the lesser of NII
statute, others will need to be addressed in ($75,000) or the excess of AGI over
Caution. At the time this briefing was IRS regulations. the applicable threshold ($350,000
prepared, the IRS had not yet issued guid- - $250,000 = $100,000). Thus, the
ance on the Medicare surtax. Until guid- Comment. Some potential issues for IRS Medicare surtax applies to $75,000.
ance is issued, it is not clear whether the guidance include whether to treat as NII
government will allow the netting of passive carried interests and investor returns from Caution. Unusual spikes in income
income and losses, which would reduce NII, private equity and hedge funds; how the may subject individuals to the 3.8 percent
or whether the tax will apply to the “gross” estimated tax payment rules will apply surtax. For example, the sale of large assets
amount of investment income. The statute, to the Medicare surtax, and application with years of capital appreciation, such as
at the same time, refers to “net” investment of the Medicare surtax to income from a residence yielding gains in excess of the
income overall and to “gross” income from foreign investments. These issues will also principal residence exclusion amount, or
particular items, such as dividends. impact 2012 year-end planning, forcing a taxable inheritance distribution from


October 4, 2012
5

an estate, may subject a taxpayer to the Gross income from interest, dividends, percent rate as short-term capital gains.
3.8 percent tax. Other common tax plan- annuities, royalties, and rents, provided Gain recognition does undergo a netting
ning techniques, such as the conversion of this income is not derived in the ordi- process, however, as explained above.
a rollover IRA into a Roth account, may nary course of an active trade or business;
push an individual into 3.8 percent tax Gross income from a trade or business If property sold was not held in a trade or
territory for everyday stock sales and divi- that is a passive activity (within the business, any gain is NII. Further, if prop-
dends also realized in the same year (see meaning of Code Sec. 469); erty was held in a trade or business, but the
strategies, below). Gross income from a trade or business individual did not materially participate,
of trading in financial instruments or the gain is NII.
Estates and trusts. For an estate or trust, commodities; and
the Medicare surtax applies to the lesser of Net gain (taken into account in com- Comment. The material participa-
undistributed net investment income for the puting taxable income) from the dispo- tion standard also applies to a trade or
year, or the amount of AGI that exceeds the sition of property, other than property business held by an estate or trust, but
dollar amount at which the highest tax rate held in an active trade or business. it remains to be seen how the IRS will
bracket begins for estates and trusts (estimat- address material participation for a trust
ed at $11,950 for 2013). Thus, the Medicare Comment. The IRS is expected to pro- or estate. However, the IRS has taken a
surtax applies to a much lower amount for vide guidance on the categories of NII. tough approach in past litigation and
trusts and estates than for individuals. Guidance is needed to identify a busi- in rulings issued to taxpayers, treating a
ness of trading in financial instruments trustee’s management of a business as pas-
STRATEGY. Trusts and estates should or commodities. sive where the trustee hired others to run
make a point of distributing their net the business day-to-day.
investment income to their beneficiaries
rather than having it taxed to the trust “One of the most important If a partnership interest or stock in an S
or estate. A trust’s NII will be taxed at corporation is disposed of, gain or loss is
a low threshold (less than $12,000),
new areas of concern for taken into account only to the extent that
while the income received by a ben- year-end tax planning in gain or loss would be taken into account
eficiary is taxed only if the much higher by the partner or shareholder, if the entity
$200,000/$250,000 thresholds are ex-
2012 is the 3.8 percent had sold all of its properties immediately
ceeded. Trustees and beneficiaries should ‘unearned income Medicare before the disposition. In effect, only net
pay particular attention to this issue. gain or loss attributable to property that is
contribution’ tax on higher- not used in an active trade or business is
Examples (4). A trust has undis- income individuals, estates taken into account.
tributed NII of $5,000, and AGI of
$20,000. The Medicare surtax applies to
and trusts.” NII is the gross income or net gain from
the lesser of $5,000 or ($20,000 minus these items, reduced by allowable deductions
the $11,950 threshold, or $8,050). Thus, that are “properly allocable” to the gross in-
the Medicare surtax applies to $5,000. If Income is NII if the trade or business is a come or net gain. For rental real property, al-
the trust had distributed all of its NII to passive activity with respect to the taxpayer. locable expenses would probably include de-
its beneficiaries, its undistributed NII If the individual materially participates in preciation and operating expenses. Treasury
would have been zero, and the Medicare the trade or business, the income is excluded guidance is expected to address when items
surtax would not have applied. from NII. The Medicare surtax does not ap- are properly allocable to income and gains.
ply to other trades or businesses conducted
(5) A trust has undistributed NII of by a sole proprietor, partnership, or S cor- STRATEGY. For capital gain property,
$15,000 and AGI of $25,000. The poration. Income, gain or loss on working taxpayers should set up a bookkeeping sys-
Medicare surtax applies to the lesser of capital is not treated as derived from a trade tem now so that in 2013 they can begin
$15,000 or ($25,000 minus $11,950, or business. to track both amounts that can increase
or $13,050). Thus, the Medicare surtax the property’s basis and investment ex-
applies to $13,050. STRATEGY. It should also be noted that penses that can reduce net gains.
certain tax-favored income under other
provisions of the tax code are provided
Net Investment Income no special breaks under the 3.8 percent
Exclusions from Tax
NII for purposes of the 3.8 percent Medi- Medicare surtax. For example, long-term The 3.8 percent Medicare surtax does not
care surtax includes: capital gains are taxed at the same 3.8 apply to nonresident aliens, corporations,

CCH Tax Briefing

6

trusts whose interests all are devoted to char- qualified plans or IRAs, but those tax- ognize income on stock based contingent
itable purposes, charitable trusts under Code able distributions nevertheless do count compensation. The employee’s control of
Sec. 501, and charitable remainder trusts towards the income threshold amount an enterprise requires that a bonus or
under Code Sec. 664. Distributions from ($250,000, $200,000, or $125,000). other form of contingent compensation
IRAs, pensions, 401(k) plans, tax-sheltered be included in his income in the year it
annuities, and eligible Code Sec. 457 plans STRATEGY. Newly-retired individuals is authorized unless special facts indicate
are excluded from NII and from the tax. may consider taking required minimum that payment is not fully possible or au-
distributions (RMDs) immediately before thorized in that year.
Comment. Currently there is no excep- year-end 2012. Taxpayers who turn age
tion for distributions from nonqualified 70½ in 2012 have the option of defer- STRATEGY. Planning for the additional
deferred compensation plans under Code ring their first RMD from their IRAs Medicare tax is complicated by the fact
Secs. 409A or 451. Some practitioners until 3½ months into the second year. that it is imposed on the combined wages
believe this was an oversight by Congress However, the 3.8 percent Medicare sur- of the employee and his/her spouse. Mar-
but the IRS has yet to speak on the matter. tax may be one more reason not to delay ried couples who have filed joint returns
a first-year distribution beyond 2012. in past years may want to explore the
Amounts treated as self-employment in- While the distribution itself is not subject benefits, if any, of filing separate returns
come and subject to self-employment tax to tax, it will increase modified adjusted for 2013 and subsequent tax years if their
are not NII. Items that are totally excluded gross income (MAGI), which may subject combined incomes make them liable for
from gross income, such as veteran’s ben- a greater portion of NII to the Medicare the additional Medicare tax.
efits, distributions from a Roth IRA, gain surtax. Bunching two years of RMDs into
excluded on the sale of a principal residence, 2013 may also subject a greater portion
or interest on tax-exempt bonds, are exclud- of Social Security income to regular in- END OF PAYROLL
ed both from NII and from modified AGI. come tax and subject the distributions to TAX HOLIDAY?
a higher rate of tax, if the Bush-era tax
STRATEGY. Taxpayers may want to con- rates sunset in whole or in part. For the past two years, the employee-share
sider, if possible, selling capital gain prop- of OASDI taxes has been reduced from 6.2
erty in 2012, before the Medicare surtax percent to 4.2 percent (with comparable re-
applies. This approach may be valuable if ADDITIONAL 0.9 PERCENT lief for self-employed individuals). Under
the taxpayer is facing large capital gains, MEDICARE TAX current law, that reduction is scheduled to
such as from the sale of a principal resi- expire after December 31, 2012. On Janu-
dence above the $250,000/$500,000 ex- Effective January 1, 2013, higher income in- ary 1, 2013, the employee-share of OASDI
clusion amounts. dividuals will be subject to an additional 0.9 taxes will revert to 6.2 percent; effectively
percent HI (Medicare) tax. This additional increasing payroll taxes across-the-board.
STRATEGY. The upcoming 3.8 percent Medicare tax should not be confused with
Medicare surtax creates an incentive for tax- the 3.8 percent Medicare surtax, also enacted Comment. Congress had initially ex-
payers to reevaluate their investment portfo- as part of the Affordable Care Act. The ad- tended payroll relief only through Febru-
lios, individual retirement accounts (IRAs), ditional Medicare tax means that the portion ary 2012, but political pressure resulted
and other assets. Taxpayers may decide this of wages received in connection with em- in a full-year extension in follow-up
is a good time to change the source of some ployment in excess of $200,000 ($250,000 February 2012 legislation. Some observ-
of their income. For example, investing in for married couples filing a joint return and ers see the same debate taking place for
tax-exempt bonds may be more attractive, $125,000 for married couples filing separate- 2013 relief, but with added ammunition
since the interest income does not enter into ly) will be subject to a 2.35 percent Medicare given to ending the relief due to budget
AGI or NII. Other types of investments tax rate. The additional Medicare tax also at- constraints now imposed against this esti-
may also generate tax-deferred income that taches to self-employed individuals. mated $110 billion measure.
would not be taxed, such as a tax-deferred
annuity, or rental real estate. Although the STRATEGY. Accelerating service-related STRATEGY. For calendar year 2012, the
latter is a passive activity, rental real estate income into 2012 may serve the dual payroll tax holiday applied for qualified
often generates a net loss after depreciation, benefit of avoiding the additional Medi- wages up to the Social Security wage base
so there would be no NII to tax. care tax and any increase in the income ($110,100). Accelerating any bonuses
tax rates as the result of sunsetting Bush- and employee recognition payments into
STRATEGY. Net investment income for era rates. Consideration should be given 2012 for employees who will be below the
purposes of the 3.8 percent Medicare sur- to ensuring that annual bonuses are paid $110,100 ceiling at year-end 2012 will
tax does not include distributions from out in 2012, as well as to electing to rec- potentially allow them to pocket two-per-


October 4, 2012
7

Comment. AMT rates – of 26 and 28
Traditional Income Acceleration/ percent (depending on amount of excess)
Deduction Deferral Strategies on the excess of alternative minimum
taxable income over the applicable ex-
Year-end 2012 presents unique challenges due to sunsetting provisions and new emption amount – are not scheduled to
taxes on the immediate horizon. Traditional year-end planning techniques never- change in 2013. However, exposure to
theless remain important. Particularly as applied to these special 2012 year-end the AMT may change as the result of the
circumstances, the following income acceleration and reciprocal deduction/credit scheduled Bush-era sunsets to the regular
deferral techniques should be considered: tax. Since a determination of AMT li-
ability requires a comparison between
Income Acceleration: regular and AMT computations, having
• Sell outstanding installment contracts regular taxes higher if the Bush-era rates
• Receive bonuses before January expire after 2012 may help lower expo-
sure to the AMT by the same amount.
• Sell appreciated assets
• Redeem U.S. Savings Bonds STRATEGY. Ignoring the possibility of be-
• Declare special dividend ing subject to the AMT can make certain
• Complete Roth conversions year-end strategies counterproductive. For
example, manipulating certain income
• Accelerate debt forgiveness income
and deductions to reduce regular tax li-
• Maximize retirement distributions ability may in fact increase AMT liability
• Accelerate billing and collections because of differences in the income and
• Avoid mandatory like-kind exchange treatment deductions allowed for AMT purposes.
• Take corporate liquidation distributions in 2012
Comment. Tax legislation passed by the
House and Senate earlier this year may be
Deductions/Credit Deferral a good indicator of the amount of an AMT
• Bunch itemized deductions into 2013/ Standard deduction into 2012 patch for 2012. In July, the Senate ap-
• Postpone bill payments until 2013 proved the Middle Class Tax Cut Act (Sen.
3412), which would set the AMT exemp-
• Pay last state estimated tax installment in 2013 tion amount for individuals at $50,600
• Postpone economic performance and at $78,750 for married couples filing
• Watch AGI limitations on deductions/credits a joint return. The House-passed bill, the
• Watch net investment interest restrictions Job Protection and Recession Prevention
Act of 2012 (HR 8) carries the same AMT
• Match passive activity income and losses exemption amounts for 2012 as the Senate
bill. If no patch is passed, the AMT exemp-
tion amounts are scheduled to be $33,750
cent more. Self-employed individuals in surances by Congressional leaders that relief for individuals and $45,000 for married
a similar position should try to accelerate will be forthcoming. couples filing a joint return for 2012.
self-employment income into 2012.
ALTERNATIVE MINIMUM TAX Comment. Even if lawmakers cannot
Comment. Extension of the payroll tax agree on a larger package of tax cut exten-
cut could be part of a year-end tax package Year-end tax planning has traditionally sions, the AMT patch is likely to be enacted
or it could be left out. If an extension of looked at a taxpayer’s potential liability for before 2013. Timing is a huge factor. The
the payroll tax holiday appears less likely by the alternative minimum tax (AMT) and IRS will need time to reprogram its process-
December, employers might consider warn- 2012 is no different. As in past years, tax- ing systems for an AMT patch. The longer
ing their employees that take-home pay will payers are waiting to see if Congress will Congress takes to pass an AMT patch, the
be less as a result, starting in January 2013. enact an AMT “patch” for 2012. The last greater the likelihood that the start of the
If expectations are that the 113th Congress patch – which provided for increased ex- 2013 filing season will be delayed.
will extend the payroll tax holiday retroac- emption amounts and use of the nonre-
tively when it convenes in January, the IRS fundable personal credits against AMT li- STRATEGY. If an individual’s regular
may authorize lower withholding upon as- ability – expired after 2011. tax liability and AMT liability tend to

CCH Tax Briefing

8

be equal from year to year, tax planning PEP. Revival of the personal exemption others expired at the end of 2011. Tech-
may want to encourage this stability. If phaseout rules would reduce or eliminate nically, the expired incentives, such as the
deductions are not so evenly spaced, a the deduction for personal exemptions for higher education tuition deduction, are
taxpayer may be able to shift some AMT- higher income taxpayers starting at “phase- not available for 2012 but there is a high
triggering items from an AMT year to out” amounts that, adjusted for inflation, probability that Congress will extend
a non-AMT year. No single factor au- would start at $267,200 AGI for joint filers them through 2012. Congress could ex-
tomatically triggers AMT liability but and $178,150 for single filers. tend them before year-end or extend them
some common factors are itemized de- retroactively after January 1, 2013.
ductions for state and local income taxes; Pease limitation. Return of the Pease limi-
itemized deductions for miscellaneous ex- tation on itemized deductions (named for
penditures, itemized deductions on home the member of Congress who sponsored the
American Opportunity Tax Credit
equity loan interest (not including inter- legislation) would reduce itemized deduc- In 2009, Congress enhanced the Hope edu-
est on a loan to build, buy or improve a tions by the lesser of: cation credit and renamed it the American
residence); and changes in income from Opportunity Tax Credit (AOTC). The
installment sales. Three percent of the amount of the temporary enhancements, including a max-
taxpayer’s AGI in excess of a threshold imum credit of $2,500, making the credit
STRATEGY. A valuable distinction be- inflation-adjusted amount projected for available for the first four years of post-sec-
tween regular tax liability and AMT 2013 to be $178,150 ($89,075 for a ondary education, and partial refundabil-
liability is scheduled to disappear after married individual filing separately), or ity for qualified taxpayers, are scheduled to
2012. Itemized medical expenses will 80 percent of the itemized deductions expire after 2012. Under current law, less
be deductible for regular tax purposes to otherwise allowable for the tax year. generous amounts will be available with the
the extent they exceed 10 percent of the revived Hope education credit.
taxpayer’s adjusted gross income (AGI), Comment. For purposes of the Pease
effective for tax years beginning after limitation, itemized deductions do not STRATEGY. Eligible taxpayers may want
December 31, 2012, with a carve-out include medical expenses, investment in- to front-load paying 2013 education ex-
for individuals age 65 and older (see terest expenses, casualty or theft losses, or penses before year-end 2012 to take ad-
below). The threshold for AMT pur- allowable wagering losses. vantage of the AOTC. Some post-second-
poses has been and will continue to be ary schools require payment for the spring
10 percent. STRATEGY. Techniques to accelerate 2013 semester in late 2012.
itemized deductions ought to be considered
PERSONAL EXEMPTION/ for those within range of a revived Pease STRATEGY. Eligible taxpayers in their
limitation. Individuals might consider ac- third or fourth year of post-secondary educa-
ITEMIZED DEDUCTION celerating gifts to charity or state income or tion, should evaluate the value of claiming
PHASEOUTS property tax payments, for example. the AOTC because the revived HOPE cred-
it may only be claimed for the first two years
Effective January 1, 2013, higher income of post-secondary education after 2013.
taxpayers may be subject to the return of EDUCATION
the personal exemption phaseout (PEP) STRATEGY. Eligible taxpayers may want
and the so-called Pease limitation on item- Education costs are a key component of year- to upgrade their laptops or other devices
ized deductions. Both of these provisions end planning for many taxpayers, In recent before year-end. An expenditure for a
had been repealed through 2012. Howev- years, a number of education tax incentives computer may qualify for the AOTC if
er, they are scheduled to return after 2012 have been enhanced, making them even more the computer is needed as a condition of
unless repeal is extended. valuable to qualified taxpayers. Grouped to- enrollment or attendance at the educa-
gether, education incentives make up a signif- tional institution.
STRATEGY. At this time, there is little icant portion of the expired or scheduled to
likelihood of Congress making any return expire tax incentives. Some of the education Comment. The value of the AOTC
of PEP and the Pease limitation ret- incentives were enhanced by the Bush-era tax is reduced for certain taxpayers because
roactive to 2012 because the 2010 Tax cuts; others fall into the tax extender category. of income thresholds. Generally, a tax-
Relief Act extended repeal of these provi- payer whose MAGI is $80,000 or less
sions through 2012. However, PEP and STRATEGY. Year-end planning for edu- ($160,000 or less for married couples
the Pease limitation could return for the cation expenses is complicated by the fact filing a joint return) may claim the
2013 tax year, which would be reflected that some of the enhanced incentives are AOTC for the qualified expenses of an
on returns filed in 2014. available through the end of 2012 but eligible student. The AOTC is reduced if


October 4, 2012
9

a taxpayer’s MAGI exceeds these thresh-
old amounts. A taxpayer whose MAGI Life Cycle Changes Important
is greater than $90,000 ($180,000 for To Year-End Strategies
married couples filing a joint return) can-
not claim the AOTC. While tax considerations are important, sometimes life gets in the way. Year-end
tax strategies should also consider personal circumstances that changed during
2012 as well as what may change in 2013. These “life cycle” changes include:
Coverdell Education
Savings Accounts • Change in filing status: marriage, divorce, death or head of household changes
• Birth of a child
Similar to IRAs, Coverdell Education Sav- • Child no longer young enough for child credit
ings Accounts (Coverdell ESAs) are accounts
• Child who has outgrown the “kiddie” tax
established to pay for qualified education
expenses. Under current law, the maximum • Casualty losses
annual contribution to a Coverdell ESA is • Changes in medical expenses
$2,000, and qualified education expenses • Moving/ relocation
include elementary and secondary school
• College and other tuition expenses
expenses. Unless extended, the maximum
annual contribution for a Coverdell ESA is • Employment changes
scheduled to decrease to $500 after 2012. • Retirement
• Personal bankruptcy
STRATEGY. Under current law, taxpay-
• Large inheritance
ers may take a Coverdell ESA distribu-
tion for qualified education expenses and • Business successes or failures
claim the AOTC/Lifetime Learning cred-
its, if eligible. This treatment, however, is
scheduled to expire at the end of 2012. STRATEGY. If the current law treatment STRATEGY. Many taxpayers now deduct-
is not extended, employee income and ing student loan interest may no longer be
STRATEGY. Taxpayers who have not wages for tax years beginning after 2012 able to do so after 2012 if the extension
contributed the maximum amount to a will include all employer-provided edu- of existing enhancements is not forthcom-
Coverdell ESA should before year-end. Al- cation assistance that pays for graduate ing. The income thresholds are scheduled
though Congress may extend the $2,000 education expenses or does not qualify as to be $55,000 for individual taxpayers
maximum threshold for another year, the a working condition fringe benefit. Em- and $75,000 for married couples filing a
$2,000 amount is certain for 2012. There ployers should investigate converting an joint return after 2012. Moreover, quali-
is no limit on the number of Coverdell ac- existing tuition reimbursement policy to fied interest will be deductible only if paid
counts that can be established for a ben- a working condition fringe benefit in during the first 60 months that interest
eficiary. However, the total contribution time to cover tuition that may be due payments are required. If a borrower is
to all accounts on behalf of a beneficiary in January. in arrears on payments, making them by
cannot exceed $2,000 for 2012. year-end 2012 may preserve a final inter-
Student Loan Interest Deduction est deduction for 2012, should Congress
not extend this popular provision.
Employer-Provided Individual taxpayers with MAGI below
Education Assistance $75,000 ($150,000 for married couples
filing a joint return) may be eligible to
Higher Education
Employer-provided education assistance deduct interest paid on qualified educa- Tuition Deduction
is scheduled to undergo some significant tion loans up to a maximum deduction
changes after 2012, unless the current en- of $2,500, subject to income phase out The above-the-line higher education tuition
hancements are extended. Under current rules. There is also no limitation as to the deduction expired after 2011. The maxi-
law, qualified employer-provided educa- number of months during which interest mum $4,000 deduction was available for
tional assistance of up to $5,250 may be ex- paid on a student loan is deductible. The qualified tuition and fees at post-secondary
cluded from income and employment taxes. enhanced treatment for the student loan institutions of learning, including colleges,
The 2010 Tax Relief Act extended the exclu- interest deduction is scheduled to expire universities, and vocational schools, subject
sion through 2012 only. after 2012. to income phaseouts.

CCH Tax Briefing

10

STRATEGY. If the higher education tu- ried individuals filing a joint return, the pooling; and an inflation-adjusted $240 per
ition deduction is revived for 2012, tax- phaseout of the child tax credit starts at month for qualified parking.
payers will need to weigh its value against $110,000 of modified AGI. For un-
the AOTC and Lifetime Learning credit. married taxpayers, the phaseout starts at STRATEGY. If Congress extends transit
Taxpayers cannot claim the higher edu- $75,000. The phaseout starts at $55,000 benefits parity in late 2012, it is unclear if
cation tuition deduction in the same tax for married couples filing separate returns. the extension would be retroactive to Janu-
year that they claim the AOTC or the ary 1, 2012, as such an extension would
Lifetime Learning credit. A taxpayer also STRATEGY. While the likelihood of ex- create significant logistical challenges for
cannot claim the higher education tu- tension of this very popular tax break is employers. A prospective extension through
ition deduction if anyone else claims the high, couples might consider the possible 2013 would be more manageable. Employ-
AOTC or the Lifetime Learning credit reduction of this credit in any custody ers should thus consider opting out of retro-
for the student in the same tax year. agreements that might be drafted under actively offering an arrangement for 2012
pending separation or divorce proceedings. that includes transit passes and van pooling
at the higher $240 level even if Congress
Teacher’s Classroom should approve an extension for 2012.
Expense Deduction State and Local
Sales Tax Deduction
Before 2012, professional educators could
Charitable Distributions from IRAs
claim a maximum $250 above-the-line an- Before 2012, qualified taxpayers could de- Before 2012, individuals age 70 ½ and older
nual deduction for qualified unreimbursed duct state and local general sales taxes in lieu could exclude from gross income qualified
expenses. These expenses include books, of deducting state and local income taxes. charitable distributions from individual re-
supplies, computers and software. The pro- The 2010 Tax Relief Act last extended the tirement accounts (IRAs). The exclusion
fessional educator must work at least 900 optional itemized deduction for state and could not exceed $100,000 per taxpayer each
hours during a school year and be a K-12 local general sales taxes, which had been tax year. The last extension of the incentive
teacher, instructor, counselor, principal or available since 2004, to tax years 2010 and expired after 2011 and, under current law, is
aide. Under current law, the deduction is 2011. Unless extended, the deduction for not available for 2012 and beyond.
not available for 2012, unless extended. state and local general sales taxes will not be
available for tax year 2012 and beyond. STRATEGY. Under current law, a tax-
Comment. The deduction has been payer can make a gift from his or her
routinely extended in past years and is STRATEGY. The deduction for state and IRA to a charity in 2012 but the amount
a good candidate for extension through local general sales taxes is a popular pro- will not be excluded from income. In-
2012 (and possibly 2013). vision which enjoys bipartisan support stead, the gift may qualify as an itemized
in Congress. Its prospects for extension tax deduction, provided it is made to a
through 2012 (or possibly even through qualified charitable organization and
OTHER TAX EXTENDERS 2013) are therefore good. Taxpayers con- substantiation requirements, as well as
FOR INDIVIDUALS templating big ticket purchases may want percentage-of-income limits, are satisfied.
to make them before the end of 2012 in
the event the deduction for state and local
Child Tax Credit Mortgage Deductions/Exclusions
sales taxes is extended through 2012 only.
Taxpayers who claim the child tax credit The existing tax code carves out a number
need to plan for its scheduled reduction af- of tax breaks directly targeted at personal
ter 2012. Absent Congressional action, the
Transit Benefits Parity residences. One of those tax breaks – the
child tax credit, at $1,000 per eligible child Qualified transportation fringe benefits may deductibility of mortgage insurance premi-
for 2012, will be $500 per eligible child, ef- be excluded from an employee’s gross income ums – expired at the end of 2011; another
fective January 1, 2013. for income tax and payroll tax purposes. More – the exclusion of forgiven mortgage debt as
generous exclusion amounts under the 2010 discharge of indebtedness income – is set to
STRATEGY. Whether the child tax credit Tax Relief Act which provided for transit expire at the end of 2012.
remains at $1,000 or drops to $500 in benefits parity among transit passes and van
2013, year-end planning that manipu- pool benefits, and qualified parking, expired Mortgage insurance premiums. For the
lates income and deductions in general after 2011. Under current law, for 2012, the period 2007 through 2011, premiums paid
should factor in the adjusted gross income excludible amount for qualified transporta- for qualified mortgage insurance could be
phaseout levels for the child tax credit, tion fringes is limited to an inflation-adjusted treated as qualified residence interest and
which would remain the same. For mar- $125 per month total for transit passes or van deducted as an itemized deduction, subject


October 4, 2012
11

to certain restrictions. Renewal of this tax liability created by the mortgage note, was no requirement that individuals
break into 2012 is uncertain at this time. even though it may later abandon its provide third-party documentation sup-
claim. This is more likely in the case of porting the purchase of qualifying prod-
STRATEGY. Amounts prepaid for quali- vacation homes, which are not covered ucts and/or costs associated with making
fied mortgage insurance, except for mort- by the exclusion, in which the lender as- energy efficient improvements, nor if these
gage insurance provided by the VA or the sumes that the borrower has other assets. qualified purchases and/or improvements
RHA, were required to be allocable to were in fact made to their residence. If the
periods beyond the year in which they are Code Sec. 25C credit is revived, Congress
paid up to 84 months and are charged
Residential Energy Incentives could impose documentation require-
to a capital account and treated as paid Two incentives, the Code Sec. 25C residen- ments similar to those imposed to prevent
in the allocable year. Therefore, although tial energy property credit, and the Code abuse of the first-time homebuyer credit.
this tax break may not be renewed for Sec. 25D residential energy efficient prop-
2012, prior premiums that had been pre- erty credit, are designed to reward taxpayers
paid may be allocable to 2012. who, on the consumer level, make qualified ESTATE/GIFT TAX
energy improvements. The Code Sec. 25C
Exclusion of discharge of indebtedness in- credit expired after 2011. The Code Sec. Estate tax planning in recent years has been
come. When a debt is forgiven, it is general- 25D credit is scheduled to expire after 2016. complicated by significant uncertainty over
ly considered imputed income to the debtor long-term federal estate and gift tax rates.
at the time of forgiveness. However, under Code Sec. 25C Credit. The Code Sec. 25C Indeed, few federal tax provisions have un-
a relief provision precipitated by the home credit was available for certain improvements, dergone as many changes as the federal es-
mortgage crisis, discharge of indebtedness including qualified windows, skylights and tate tax rules in recent years. The current
income is excluded from gross income if the doors, building insulation systems, certain estate and gift tax effective through 2012 is
indebtedness discharged is “qualified prin- roofing materials, central air conditioning set at a maximum rate of 35 percent with a
cipal residence indebtedness” that is dis- systems, and certain water heaters. $5.12 million exemption amount. Unless
charged any time after December 31, 2006, extended, the maximum estate tax rate will
and before January 1, 2013. Code Sec. 25D Credit. The Code Sec. 25D revert to 55 percent after 2012 with a $1
credit is available for qualified solar electric million exemption amount.
“Qualified principal residence indebted- property, solar water heating property, fuel cell
ness” is defined as “acquisition indebted- property, small wind energy property, quali- Comment. The maximum estate tax
ness” of $2 million or less. “Acquisition fied geothermal heat pump property. The tax- rate is expected to increase after 2012,
indebtedness” is any indebtedness incurred payer’s residence must be his or her principal but likely not to 55 percent. A top rate
for the acquisition, construction, or sub- residence and be located in the U.S. Purchas- of 45 percent with a $3.5 million exemp-
stantial improvement of the principal resi- ers of new homes may qualify for the credit. tion amount has reportedly been discussed
dence and is secured by the residence. This among Congressional Democrats but there
is an expiring provision that likely may be STRATEGY. Prospects for extending Code is also significant support for keeping the
renewed, given that many homeowners are Sec. 25C are uncertain. Several bills to maximum rate at 35 percent with an
still underwater on their mortgages. extend the credit through 2012 or 2013 inflation-adjusted $5 million exemption
have been introduced in Congress but amount. A separate $1 million exemption
STRATEGY. Determining precisely the have either languished in committee or from gift tax has also been proposed.
tax year in which debt forgiveness occurs have been rejected. Installation of the
may enter into year-end planning, both energy-saving equipment must take place STRATEGY. Gift-giving, ideally on an
for purposes of claiming the exclusion in in the year for which the credit is claimed, annual basis that includes 2012, should
2012 under current law and for purposes as a mere sales contract dated in the year continue to form part of one’s overall es-
of accelerating or postponing discharge of of the credit is insufficient. tate plan. The annual gift tax exclusion
indebtedness income in those instances per donee on which no gift tax is due is
where the exclusion does not apply. Dis- The Code Sec. 25D credit, however, re- $13,000 for 2012 (and is projected to
charge of indebtedness income, regardless mains available through 2016, and is not be $14,000 in 2013), with $26,000 al-
of the applicability of the exclusion, gen- subject to any cap. lowed to each donee by married couples
erally will not be recognized before any filing a split-gift election ($28,000 in
sale or foreclosure takes place. Discharge Comment. In 2011, the Treasury In- 2013). Making a gift at year-end 2012
of indebtedness income may also not take spector General for Tax Administration to take advantage of this annual, per-
place until well after a sale if the lender (TIGTA) uncovered significant abuse of donee exclusion should be considered by
pursues the borrower under the personal the Code Sec. 25C credit because there anyone with even modest wealth.

CCH Tax Briefing

12

STRATEGY. Combining the gift tax ex- certain longer production period property year in which substantial first-year writeoffs
clusion with the zero percent capital gains and certain transportation property). for the purchase of a business automobile
rates available through 2012 for donees may be available.
in the 10 or 15 percent income tax brack- To be eligible for bonus depreciation, quali-
et might also prove advantageous, espe- fied property must be depreciable under the Code Sec. 168(k)(2)(F)(i) increases the
cially if appreciated property is gifted to Modified Accelerated Cost Recovery System first-year depreciation allowed for vehicles
older children who are beyond the reach (MACRS) and have a recovery period of 20 subject to the Code Sec. 280F luxury-vehi-
of the “kiddie tax,” which taxes at the years or less. These requirements encompass cle limits, unless the taxpayer elects out, by
parent’s marginal rate certain unearned a wide-variety of assets. The property must $8,000, to which the additional first-year
income of a child. be new and placed in service before January depreciation deduction applies. The maxi-
1, 2013 (January 1, 2014 for certain lon- mum depreciation limits under Code Sec.
Time for large year-end gifts? The combi- ger production period property and certain 280F for passenger automobiles first placed
nation of a high unified gift and estate tax transportation property). in service by the taxpayer during the 2012
exclusion of $5.12 million that will sunset calendar year are: $11,160 for the first tax
at the end of 2012 and the relatively low Example. Qualifying assets with a five- year ($3,160 if bonus depreciation is not
valuation of many businesses as the result of year life for depreciation purposes are taken); $5,100 for the second tax year;
the economic downturn may enhance the purchased for $500,000 and placed into $3,050 for the third tax year; and $1,875
incentive for making large year-end gifts. service in January, 2012. The taxpayer for each tax year thereafter. The maximum
Some taxpayers may also be willing to trans- may claim $250,000 bonus depreciation depreciation limits under Code Sec. 280F
fer more than $5.12 million at this time, and $50,000 first year depreciation. for trucks and vans first placed in service
when the unified gift and estate tax rate is during the 2012 calendar year are $11,360
at a relatively low 35 percent and poised to Comment. The rules for determining for the first tax year ($3,360 if bonus depre-
rise to as much as a maximum 55 percent the acquisition date of an asset changed ciation is not taken); $5,300 for the second
starting in 2013. when 100 percent bonus depreciation tax year; $3,150 for the third tax year; and
dropped to 50 percent. Special rules also $1,875 for each tax year thereafter.
apply to self-constructed property.
BUSINESS PLANNING STRATEGY. Under Code Sec. 179(b)
STRATEGY. The equipment eligible for (5), not more than $25,000 of the cost
Year-end planning for business, like year- bonus depreciation must be placed in ser- of a heavy SUV can be written off un-
end planning for individuals, is complicated vice, and not merely purchased, by year- der Code Sec. 179. Nevertheless, heavy
by the number of expired or soon-to-expire end to be eligible in 2012. Placed in SUVs (sport utility vehicles and pickup
tax incentives. Many of these incentives service generally requires installation and trucks with a gross vehicle weight rating
have routinely been extended in past years. ready-for-use in the business. Title must in excess of 6,000 pounds) are exempt
However, their fate in a budget-conscious also pass. Payment under an installment from the luxury vehicle depreciation caps.
Congress is uncertain. agreement beyond 2012, however, will Therefore, combining Code Sec. 179 ex-
not impact on claiming bonus deprecia- pensing with full 50 percent bonus de-
tion for 2012. preciation can result in a substantial first
BONUS DEPRECIATION year write-off of a heavy SUV’s purchase
STRATEGY. Bonus depreciation is not price if done before 2013.
In recent years, Congress has used bonus de- mandatory. Certain taxpayers should
preciation to encourage economic growth. consider electing out of bonus deprecia- Half and quarter year conventions. The
Currently, a special 50-percent first year bo- tion to spread depreciation deductions half-year convention treats all property placed
nus depreciation allowance is provided for more evenly over future years. in service during any tax year (or disposed of
qualified property. This allowance is sched- during any tax year) as placed in service (or
uled to expire after 2012 (2013 in the case Code Sec. 280F dollar limitations. Bo- disposed of) at the midpoint of that tax year.
of certain longer production period prop- nus depreciation also relates to the vehicle The amount of allowable depreciation in a tax
erty and certain transportation property). depreciation dollar limits under Code Sec. year in which the half-year convention ap-
280F. This provision imposes dollar limita- plies is one half the amount that would be al-
Comment. For a temporary period, tions on the depreciation deduction for the lowed by applying the applicable depreciation
taxpayers could take advantage of 100 year in which a taxpayer places a passenger method for a full tax year. The mid-quarter
percent bonus depreciation. However, automobile in service within a business, and convention must be used instead of the half-
100 percent bonus depreciation expired for each succeeding year. Unless bonus de- year convention if, during any tax year, the
at the end of 2011 (2012 in the case of preciation is extended, 2012 will be the final aggregate bases of all property (other than re-


October 4, 2012
13

alty) that is placed in service during the last property must be newly purchased new the $139,000 expensing limit, then defer
three months of that year exceed 40 percent or used property, rather than property you in 2013 to maximize the $25,000 limit
of the aggregate bases of all property placed in previously owned but recently converted (or higher, should Congress decide to be
service during the tax year. The mid-quarter to business use. Examples of types of prop- more generous).
convention treats all property placed in ser- erty that would qualify for Code Sec. 179
vice during any quarter of a tax year (or dis- expensing are office equipment or equip- The Code Sec. 179 deduction is also lim-
posed of during any quarter of a tax year) as ment used in the manufacturing process. ited to a taxpayer’s trade or business taxable
having been placed in service (or disposed of) income. Any excess beyond taxable income
at the midpoint of that quarter. STRATEGY. Year-end may be the time to may be carried forward (unlike bonus depre-
invest in off-the-shelf computer software. ciation, which may generate a net operating
STRATEGY. Bonus depreciation is not Code Sec. 179 expensing is allowed for loss that may be carried back or carried for-
subject to half or quarter year conven- off-the-shelf computer software placed in ward). The taxable income limit, however,
tions; a qualifying asset purchased on service in tax years beginning before 2013. is applied to all trades or businesses owned
the last day of the tax year qualifies for by the taxpayer. In another twist, wages are
as much bonus depreciation as an asset Caution. Real property generally is considered when computing the taxable
purchased on January 1st of the same year. excluded from Code Sec. 179 expensing. income limit, therefore enabling some em-
However, the remainder of regular depre- The 2010 Tax Relief Act provided that ployees with side businesses at home to ex-
ciation for year-end purchases is subject to qualified leasehold property, qualified pense the full value of equipment purchases.
those conventions. restaurant property and qualified retail
improvement property placed in service Interplay with bonus depreciation. The
in 2010 or 2011 were eligible for spe- purchased property may qualify for both
CODE SEC. 179 EXPENSING cial expensing rules. However, starting Code Section 179 expensing and bonus de-
in 2012, no such expansion of Code Sec. preciation. Code Sec 179 expensing should
Many taxpayers have grown accustomed to 179 expensing has been available. be taken first, followed by bonus deprecia-
enhanced Code Sec. 179 expensing. How- tion and then regular first-year depreciation.
ever, the generous dollar limitation and STRATEGY. If qualified equipment pur- For example, a 2012 purchase of $400,000
investment limitations are scheduled to chases for the year exceed the expensing in assets that qualify as five-year property
plunge after 2012. dollar limit (but not the overall invest- for depreciation purposes would be enti-
ment ceiling), the taxpayer may decide tled to a $139,000 Code Sec. 179 deduc-
Code Sec. 179 gives businesses the option of to split the expensing election among the tion, a $130,500 bonus depreciation and a
claiming a deduction for the cost of qualified new assets any way it chooses. It may be $26,100 regular depreciation deduction as-
property all in its first year of use rather than more valuable to expense assets with the suming a half-year convention.
claiming depreciation over a period of years. longest depreciation recovery periods. As
Under current law, the dollar limitation for long as the taxpayer starts using the newly De minimis expensing alternative. New
2012 is $139,000 with a $560,000 invest- purchased business equipment before the de minimis expensing rules allow a taxpayer
ment ceiling placed on the purchase of all oth- end of the tax year, the taxpayer gets the to deduct certain amounts paid or incurred
erwise qualifying property. The Code Sec. 179 entire expensing deduction for that year. to acquire or produce a unit of tangible
dollar limit is scheduled to drop to $25,000 The amount that can be expensed depends property if the taxpayer has an Applicable
for 2013 with a $200,000 investment ceiling. upon the date the qualified property is Financial Statement (AFS), written account-
placed in service; not when the qualified ing procedures for expensing amounts paid
Comment. A precipitous drop has al- property is purchased or paid for. or incurred for such property under certain
ready taken place from $500,000 with a dollar amounts, and treats such amounts as
$2 million investment ceiling applicable Comment. While a decision on what to expenses on its AFS in accordance with its
to 2010 and 2011. expense need not be made until 2012 re- written accounting procedures. An overall
turns are filed, proactive management of ceiling limits the total expenses that a tax-
STRATEGY. Businesses may want to ac- qualifying purchases before year end can payer may deduct under the de minimis rule.
celerate purchases into 2012 to take ad- lead to higher tax savings.
vantage of the still generous Code Sec. STRATEGY. The de minimis expensing
179 expensing dollar and investment STRATEGY. The limitations are per-year rule is especially useful to businesses that
amounts. Qualified property must be tan- and not cumulative. The optimal bal- may exceed the $560,000 investment
gible personal property, actively used in ance between 2012 and 2013 in pur- ceiling or $139,000 dollar limit im-
the business, and for which a depreciation chasing equipment, therefore, would be to posed in 2012 for use of Code Sec. 179
deduction would be allowed. Qualified engage in 2012 purchases that maximize expensing. The de minimis expensing rule

CCH Tax Briefing

14

applies to amounts paid or incurred (to RESEARCH TAX CREDIT STRATEGY. The program expired at the
acquire or produce property) in tax years end of 2011 but may be extended by
beginning on or after January 1, 2012. The Code Sec. 41 research tax credit expired Congress retroactively in 2012 or into
after 2011. However, the research credit 2013. Treasury allocated $3.6 billion in
enjoys significant bipartisan support and investment authority to CDEs in 2011,
QUALIFIED LEASEHOLD/ is a strong candidate for extension through which in the meantime is positioned to
RETAIL IMPROVEMENTS, 2012 (and possibly through 2013). The generate approximately $1.4 billion in
question is when Congress will extend the NMTCs. Taxpayers interested in claim-
RESTAURANT PROPERTY research credit: either before year-end 2012 ing NMTCs (yields currently are very
Before 2012, qualified leasehold improve- or in early 2013 and make an extension ret- competitive) should be on the lookout for
ment property, qualified restaurant property roactive to January 1, 2012. investment opportunities and be aware of
and qualified retail improvement property participation deadlines sensitive to year-
were eligible for a 15-year recovery period. Comment. The alternative simplified end opportunities to claim the credit.
The qualified property had to be placed in credit method also expired after 2011.
service before January 1, 2012. Under current Under the alternative simplified credit
law, this incentive is not available for qualified method, a taxpayer’s research credit is
More Business Tax Extenders
property placed in service after December 31, equal to 14 percent of the amount by A number of other business tax extenders
2011. However, Congress could extend the which the qualified research expenses for expired after 2011. They include (not an
incentives retroactively to January 1, 2012. the tax year exceed 50 percent of the av- exhaustive list):
erage qualified research expenses for the
STRATEGY. Taxpayers that did not take three preceding tax years. The rate is re- 100 percent exclusion for gain on sale of
advantage of the incentive before 2012 duced to six percent if the taxpayer has no qualified small business stock
may benefit from an extension for prop- qualified research expenses in any one of Enhanced deduction for charitable con-
erty placed in service before January 1, the three preceding tax years. tributions of food inventory
2013. Of course, this is speculative but Enhanced deduction for corporate char-
taxpayers should evaluate the benefits of itable contributions of book inventory
any retroactive extension. NEW MARKETS TAX CREDIT Enhanced deduction for corporate char-
itable contributions of computers
The new markets tax credit (NMTC) is de- Expensing of brownfields remediation
WORK OPPORTUNITY signed to encourage investments, loans, or costs
TAX CREDIT financial counseling for businesses and real Employer wage credit for activated mili-
estate projects in low-income communities. tary reservists
The Work Opportunity Tax Credit (WOTC) Under Code Sec. 45D, taxpayers may claim Subpart F exceptions for active financ-
rewards employers that hire individuals from the credit by making an equity investment ing income
targeted groups with a tax credit. Under cur- in a community development entity (CDE), Look through rule for related controlled
rent law, the WOTC is not available for 2012 which in turn will invest the funds in the low- foreign corporation payments
except for the target group applicable to qual- income community. Both individuals and Railroad track maintenance credit
ified veterans. The Vow to Hire Heroes Act corporations can invest in a CDE. The invest- Seven year recovery period for motors-
of 2011 (Heroes Act) extended the WOTC ment must be acquired at its original issue, ports entertainment complexes
for unemployed veterans and unemployed either directly or through an underwriter. Mine rescue team training credit
veterans with service connected disabilities Indian employment credit
through 2012. The Heroes Act did not ex- The Treasury Department allocates credits Accelerated depreciation for business
tend the non-veteran WOTC provisions. to the CDEs. Taxpayers may claim a total property on Indian reservations
credit of 39 percent of the original amount Special expensing rules for qualified film
STRATEGY. Under current law, the win- invested. The credit is claimed over seven and television productions
dow for hiring a qualified veteran to claim years: five percent in the first three years, six Election to expense advanced mine safe-
the WOTC is short. The qualified veteran percent over the succeeding four years. Be- ty equipment
must begin work for the employer before cause the majority of investments have in- Tax incentives for the District of Columbia
January 1, 2013. For-profit and non-prof- volved real estate, Treasury and the IRS have Tax incentives for empowerment zones
it employers can benefit from the WOTC if recently issued regulations to encourage in-
they hire a qualified veteran before January vestments, primarily as working capital and Comment. In August 2012, the Senate
1, 2013. The WOTC for qualified veterans equipment loans, in businesses that are not Finance Committee approved the Family
can be as high as $9,600. involved in real estate. and Business Tax Cut Certainty Act of


October 4, 2012
15

2012. The bill would extend many of the cant change effective 2013. Under current to tax on distributions from the health FSA
individual and business tax extenders, law, taxpayers who itemize deductions may after 2012.
but not brownfields remediation expens- claim an itemized deduction for qualified
ing, certain tax incentives for the District unreimbursed medical expenses to the ex- STRATEGY. Before the Affordable Care Act,
of Columbia, and the enhanced deduc- tent the expenses exceed 7.5 percent of ad- many employers imposed a $5,000 maxi-
tion limits for charitable contributions of justed gross income (AGI). Effective for mum salary reduction contribution cap to a
computer equipment and book inventory. tax years beginning after December 31, health FSA. Individuals with contribution
At this point, however, it is unclear if the 2012, the 7.5 percent threshold increases limits above $2,500 for 2012 should make
full Senate will take up the bill as written to 10 percent. decisions about the priority of certain health
after the November elections. care decisions before the end of 2012, espe-
STRATEGY. Although medical expenses cially where expenses that can be avoided in
are often unforeseen, taxpayers who an- 2013 can be accelerated to 2012.
HEALTH CARE ticipate incurring qualified medical ex-
penses for purposes of the itemized deduc- STRATEGY. Unlike past years, health
Year-end planning also should take into action, such as for elective surgery, may wish FSA dollars cannot be used in 2012 to
count the various tax provisions affecting to accelerate those expenses into 2012. If pay for over-the-counter medications (ex-
health care costs. The Patient Protection and the expenses can be accelerated, it may cept insulin). Effective January 1, 2011,
Affordable Care Act and its companion bill, be more advantageous to claim them in distributions from health FSAs are al-
the Health Care and Education Reconcilia- 2012 with the threshold at 7.5 percent lowed to reimburse the cost of over-the-
tion Act (collectively known as the Affordable rather than in subsequent years with a 10 counter medicines only if they are pur-
Care Act), enacted a host of tax-related pro- percent threshold. chased with a prescription. Items that
visions impacting individuals and business. are not medicines continue to qualify, in-
Some of the tax provisions were effective im- STRATEGY. The Affordable Care Act cluding bandages, and diagnostic devices,
mediately, others in 2011 and 2012, and more carved out an important but temporary such as blood sugar test kits.
in 2013 and beyond. In addition to the 3.8 exception to the 10 percent threshold
percent Medicare contributions tax and the for individuals age 65 and older. Tax- Comment. The $2,500 amount is in-
0.9 percent Medicare tax already discussed, payers (or their spouses) who are age 65 dexed for inflation, but only for tax years
several other provisions in the Affordable Care or older before the close of the tax year beginning after December 31, 2013.
Act impact year-end 2012 tax planning. (for tax years beginning after December
31, 2012 and ending before January 1,
Comment. Tax planning for health care 2017), may continue to apply the 7.5
Medical Loss Ratio Rebates
is complicated by uncertainty over the fate percent threshold. The Affordable Care Act requires health
of the Affordable Care Act until after the insurance issuers to submit data on the
November elections. Governor Mitt Rom- Comment. The Affordable Care Act only proportion of premium dollars spent on
ney, the Republican Party candidate for increased the threshold from 7.5 percent to clinical services and quality improve-
President, has said he will repeal the Af- 10 percent for regular income tax purposes. ment. If the percentage does not meet
fordable Care Act if elected, but has indi- The AMT treatment of the itemized de- minimum standards, issuers must pro-
cated his support for continuing some of the duction remains unchanged at 10 percent. vide rebates to enrollees.
provisions. If re-elected, President Obama There is no age 65 exception for the 10 per-
has promised to move forward with imple- cent threshold for AMT purposes. The first round of medical loss ratio (MLR)
mentation of the Affordable Care Act, in- rebates under the Affordable Care Act took
cluding the so-called individual mandate, place in 2012.
which was upheld by the U.S. Supreme
Health Flexible
Court, and the employer-shared responsi- Spending Arrangements STRATEGY. Whether an MLR rebate
bility payment provision. These two provi- is taxable depends on a number of vari-
sions are scheduled to take effect after 2013. Health flexible spending arrangements ables. If a tax benefit was previously
(health FSAs) are a popular savings ve- gained on the premiums now being re-
hicle for qualified health care expenses. bated, the rebate is taxable; otherwise, the
Itemized Deduction After 2012, however, the maximum salary rebated premiums are generally tax free to
for Medical Expenses reduction contribution to a health flexible the recipient. Taxpayers taking inventory
spending arrangement (health FSA) will be of income and deductions for purposes of
The itemized deduction for medical ex- capped at $2,500. Any salary reductions in year-end 2012 tax planning should keep
penses is scheduled to undergo a signifi- excess of $2,500 will subject the employee this additional income source in mind.

CCH Tax Briefing

2012 Year End Tax Planning

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