2012 Year End Tax Planning


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2012 Year End Tax Planning

  1. 1. CCH Tax Briefing2012 Year-End Tax PlanningOctober 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 invest- ing 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 blockIncome 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 created0.9 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 incomeBusiness 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. Click to continue on next page
  2. 2. 2012 Year-End Tax Planning2 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- Click to continue on next page CCH Tax Briefing ©2012 CCH. All Rights Reserved.
  3. 3. 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 stockor 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 adjustedTo obtain long-term rates, investors musthold 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 assetis acquired and ends on the day the asset isdisposed of. Stock is generally treated as soldon the trade date, the date the taxpayer enters sold the stock on December 1, 2012, the sells shares and then must obtain sharesinto a contract to sell the stock. The trade taxpayer’s holding period is more than one to close out the transaction. If the stockdate should be distinguished from the settle- year, and gains (or losses) are long-term. price falls, so that the investor will realizement date, the date that the investor delivers a gain, the gain is realized on the tradethe stock certificate and receives payment. Example. A taxpayer bought stock on date, when the seller directs the broker toThe settlement date may be 3-5 days after the December 28, 2011 and sold it on De- purchase shares. If the price rises, so thattrade 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- Click to continue on next page CCH Tax Briefing
  4. 4. 2012 Year-End Tax Planning4 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 Click to continue on next page CCH Tax Briefing ©2012 CCH. All Rights Reserved.
  5. 5. 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; andthe 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 oryear, or the amount of AGI that exceeds the sition of property, other than property business held by an estate or trust, butdollar amount at which the highest tax rate held in an active trade or business. it remains to be seen how the IRS willbracket begins for estates and trusts (estimat- address material participation for a trusted at $11,950 for 2013). Thus, the Medicare Comment. The IRS is expected to pro- or estate. However, the IRS has taken asurtax applies to a much lower amount for vide guidance on the categories of NII. tough approach in past litigation andtrusts 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 providedNet Investment Income no special breaks under the 3.8 percent Exclusions from TaxNII for purposes of the 3.8 percent Medi- Medicare surtax. For example, long-term The 3.8 percent Medicare surtax does notcare surtax includes: capital gains are taxed at the same 3.8 apply to nonresident aliens, corporations, Click to continue on next page CCH Tax Briefing
  6. 6. 2012 Year-End Tax Planning6 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- Click to continue on next page CCH Tax Briefing ©2012 CCH. All Rights Reserved.
  7. 7. 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 Click to continue on next page CCH Tax Briefing
  8. 8. 2012 Year-End Tax Planning8 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 Click to continue on next page CCH Tax Briefing ©2012 CCH. All Rights Reserved.
  9. 9. 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 EducationSavings Accounts • Change in filing status: marriage, divorce, death or head of household changes • Birth of a childSimilar to IRAs, Coverdell Education Sav- • Child no longer young enough for child creditings Accounts (Coverdell ESAs) are accounts • Child who has outgrown the “kiddie” taxestablished to pay for qualified educationexpenses. Under current law, the maximum • Casualty lossesannual contribution to a Coverdell ESA is • Changes in medical expenses$2,000, and qualified education expenses • Moving/ relocationinclude elementary and secondary school • College and other tuition expensesexpenses. Unless extended, the maximumannual contribution for a Coverdell ESA is • Employment changesscheduled 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 belowEducation Assistance $75,000 ($150,000 for married couples filing a joint return) may be eligible to Higher EducationEmployer-provided education assistance deduct interest paid on qualified educa- Tuition Deductionis scheduled to undergo some significant tion loans up to a maximum deductionchanges after 2012, unless the current en- of $2,500, subject to income phase out The above-the-line higher education tuitionhancements 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 fortional assistance of up to $5,250 may be ex- paid on a student loan is deductible. The qualified tuition and fees at post-secondarycluded 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, subjectsion through 2012 only. after 2012. to income phaseouts. Click to continue on next page CCH Tax Briefing
  10. 10. 2012 Year-End Tax Planning10 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 Click to continue on next page CCH Tax Briefing ©2012 CCH. All Rights Reserved.
  11. 11. October 4, 2012 11to certain restrictions. Renewal of this tax liability created by the mortgage note, was no requirement that individualsbreak 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. 25CExclusion of discharge of indebtedness in- credit expired after 2011. The Code Sec. Estate tax planning in recent years has beencome. When a debt is forgiven, it is general- 25D credit is scheduled to expire after 2016. complicated by significant uncertainty overly 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 currentincome is excluded from gross income if the doors, building insulation systems, certain estate and gift tax effective through 2012 isindebtedness discharged is “qualified prin- roofing materials, central air conditioning set at a maximum rate of 35 percent with acipal residence indebtedness” that is dis- systems, and certain water heaters. $5.12 million exemption amount. Unlesscharged any time after December 31, 2006, extended, the maximum estate tax rate willand 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 cellness” is defined as “acquisition indebted- property, small wind energy property, quali- Comment. The maximum estate taxness” 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 ratefor 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 discusseddence and is secured by the residence. This among Congressional Democrats but thereis an expiring provision that likely may be STRATEGY. Prospects for extending Code is also significant support for keeping therenewed, given that many homeowners are Sec. 25C are uncertain. Several bills to maximum rate at 35 percent with anstill 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. Click to continue on next page CCH Tax Briefing
  12. 12. 2012 Year-End Tax Planning12 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- Click to continue on next page CCH Tax Briefing ©2012 CCH. All Rights Reserved.
  13. 13. October 4, 2012 13alty) that is placed in service during the last property must be newly purchased new the $139,000 expensing limit, then deferthree months of that year exceed 40 percent or used property, rather than property you in 2013 to maximize the $25,000 limitof the aggregate bases of all property placed in previously owned but recently converted (or higher, should Congress decide to beservice 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. 179vice 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 taxablehaving been placed in service (or disposed of) income. Any excess beyond taxable incomeat 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 bothCODE 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 shouldMany 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 $400,000investment limitations are scheduled to chases for the year exceed the expensing in assets that qualify as five-year propertyplunge 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 aclaiming 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. AsUnder current law, the dollar limitation for long as the taxpayer starts using the newly De minimis expensing alternative. New2012 is $139,000 with a $560,000 invest- purchased business equipment before the de minimis expensing rules allow a taxpayerment ceiling placed on the purchase of all oth- end of the tax year, the taxpayer gets the to deduct certain amounts paid or incurrederwise qualifying property. The Code Sec. 179 entire expensing deduction for that year. to acquire or produce a unit of tangibledollar limit is scheduled to drop to $25,000 The amount that can be expensed depends property if the taxpayer has an Applicablefor 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 Click to continue on next page CCH Tax Briefing