Tax and Estate Planning: Opportunities For 2012

February 28, 2012

As we move into 2012, there are a number of favorable federal tax provisions that are set to expire at the end of the year absent action by Congress and the President.  This article will highlight a few of these favorable provisions that currently offer tax and estate planning opportunities for the rest of the year and discuss the new “Medicare” taxes scheduled for 2013.

For income tax purposes, the top individual federal income tax rate for 2012 remains at 35%.  It is scheduled to increase to 39.6% for 2013.  Qualified capital gains and dividends for 2012 remain taxed at a maximum 15% (0% for taxpayers in the 10% and 15% income tax brackets).  The qualified capital gains tax rate is scheduled to increase to 20% in 2013 and qualified dividends are scheduled to be taxed at ordinary income rates in 2013 (with the top income tax rate scheduled to increase to 39.6%, as mentioned above).  To the extent these federal tax rates are to rise next year, acceleration of income into 2012 may offer potential tax savings.

For 2012, high income individuals will not be subject to any reduction in the total amount of otherwise allowable itemized deductions on their personal federal income tax returns.  However, a limitation in the total amount of such itemized deductions for high income individuals is scheduled for 2013.  (Last Fall, President Obama proposed for 2013, a further limitation on itemized deductions for high-income individuals.  Such proposal has not been enacted into law.)  For 2012, high income individuals will also not be subject to the phase-out of the personal exemption deduction on their personal federal income tax returns.  The phase-out of such personal exemption deduction for high-income individuals is scheduled for 2013.  As a consequence, as we move into 2013, high-income taxpayers’ ability to reduce federal taxes from such items will diminish.

For estate planning purposes, the top federal estate tax rate in 2012 is 35% and the applicable estate tax exclusion amount is $5,120,000 per person.  The top federal estate tax rate in 2013 is scheduled to jump to 55% and the applicable exclusion is scheduled to fall significantly to $1 million per person.  The top federal gift tax rate for 2012 is 35% and the lifetime gift tax exemption amount is $5,120,000 per person.  The top federal gift tax rate in 2013 is scheduled to jump to 55% and the lifetime gift tax exemption amount is scheduled to also fall significantly to $1 million per person.  In addition to the foregoing, the first $13,000 of gifts by a donor each year to each donee is excluded under the annual gift tax exclusion.  Furthermore, there remains an unlimited gift tax exclusion for qualifying educational and medical payments.  The federal generation-skipping transfer tax rate in 2012 is 35% and the generation-skipping transfer tax exemption amount is $5,120,000 per person.  The federal generation-skipping transfer tax rate is scheduled to rise to 55% in 2013 and the exemption amount is scheduled to fall to approximately $1.3 million per person. 
Based upon the above-described $5,120,000 per person exemption amounts, there currently exists an unprecedented opportunity for wealthy individuals to gift assets to children and grandchildren without gift tax or generation-skipping transfer tax; however, such gifts must be made before the end of this year.

As part of the major Health Care Reform legislation passed in 2010, new “Medicare” taxes are scheduled for 2013 for high-income individuals.  A new 3.8% tax will be applied to unearned income.  This new tax will apply to capital gains, dividends, interest and rental income for high-income taxpayers.  In addition, a new 0.9% tax will apply to the earned income (i.e., salaries, wages) of high-income earners.  These additional taxes can potentially push the effective federal tax rate for certain high-income taxpayers to over 44%.  For appreciated assets that can be sold at capital gains rates, a disposition by certain high-income individuals in 2012 instead of 2013 could potentially save 8.8% in federal taxes (due to the 2013 5% rise in capital gains rates and new 3.8% tax on unearned income).

Because many of the federal tax laws are creatures of politics, this year’s Presidential and Congressional elections should be closely watched as the outcome will determine whether we might expect any modifications to the significant changes in federal tax laws scheduled for next year.  Due to the ongoing State of California budget crisis, State of California tax rates continue to be the subject of political debate.

At the end of last year, Governor Jerry Brown announced that he will ask the California Legislature to place on the November, 2012 ballot a tax initiative which would increase personal income tax rates as much as 2% on high income individuals (the top individual California income tax rate for 2012 is currently 9.3%) and increase the sales tax by a half cent.  This tax initiative should also be closely watched.

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