Tax Update: The Certainty of Uncertainty

By Steven Smith | Investment Management

Jan 25

It seems like only yesterday that the December 2010 compromise was reached to extend the Bush income tax cuts and to temporarily liberalize the estate and gift tax for two years. In addition, two new taxes imposed by the Affordable Care Act go into effect in 2013—if the law is neither repealed nor declared unconstitutional by the Supreme Court. With the Presidential election looming, it’s hard to know whether a new compromise will occur before the end of the year…or even after. What had been a two-year planning window may now only be a few months. Here are some of the highlights:

  • Individual rates. Brackets for 2012 are 10, 15, 28, 33 and 35%. The top bracket is scheduled to be 39.6% in 2013.
  • Capital Gains. Long term capital gains rates remain at 15% (0% for taxpayers in the 10 and 15% brackets). The top rate is scheduled to revert to 20%. Qualifying dividends, which are now taxed at capital gains rates are slated to revert to being taxed at ordinary income rates for all taxpayers.
  • Payroll tax. A compromise in December 2011 extended the payroll tax holiday (from 6.2% to 4.2%) for just two months.
  • Extenders. The host of temporary provisions affecting almost all taxpayers is scheduled to expire.
  • AMT. An inflation adjustment for the Alternative Minimum Tax for only 2011 has expired, possibly affecting 31 million taxpayers. Congress will probably patch this, as they do every year. (Is this any way to run a country?)
  • Health Care Taxes. The Affordable Care Act imposes two significant tax increases for high income taxpayers ($200,000 for individuals, $250,000 for joint filers) scheduled to go into effect in 2013. The Medicare payroll tax increases by .09%. A Medicare investment tax of 3.8% is imposed on nonbusiness, net investment income from interest, dividends, annuities, royalties, rents, and capital gains.  Distributions from IRA’s and qualified plans are exempt.
  • Estate and Gift Taxes. The word temporary occurs 43 times in the 30 pages of estate and gift tax legislation passed at the end of 2010. For the remainder of 2012, the estate tax exemption is $5,000,000 ($10,000,000 for couples, even those who disdain planning due to the portability provision.) We covered the changes in depth in our March 2011 newsletter. Most notably, the gift tax exemption is also $5,000,000 for the remainder of the year. Both exemptions will return to the $1,000,000 level in 2013. The best immediate planning opportunities are probably those that take advantage of the gift tax exemption, especially for those people who believe President Obama and the Democrats have the upper hand in the political battles.
  • New Cost Basis Rules. This year, for the first time, custodians will be reporting cost basis information on Form 1099-B for equity shares acquired on or after January 1, 2011. Next year, custodians will begin to report cost basis for mutual funds and ETF’s acquired on or after January 1, 2012. Preview the new form. Phase III will include fixed-income, options, warrants, rights, derivatives, and commodities acquired on or after January 1, 2013.Accordingly, going forward, investors will have both uncovered and covered pools of shares, depending on when they were acquired. Custodians, generally, unless instructed otherwise, will sell from the uncovered pool first. The default method for mutual funds has always been average cost; which we are maintaining unless otherwise instructed by our clients. (If you want to make a change, it needs to be done within one year of acquisition or the date of first disposition, whichever is first.) Other methods are first in, first out (FIFO) and specific identification. Some custodians are also offering customized harvesting methods.Most interesting, is the ability to change from average cost to another method for subsequently acquired shares. Formerly, once average cost was selected for a particular mutual fund holding, that method was set in stone.

More Information

It is difficult for folks to keep track of all of the changes, and we need all of the tools we can get. To that end, Forefield offers a short video summarizing the “Federal Income Tax Landscape 2012 & 2013.”

 

And, as we do every year, we provide a comprehensive guide to a wide range of new tax numbers in the downloadable “2012 Key Numbers.

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