Unless legislative action occurs, 2012 marks the last year of a historically low tax environment. Beginning in 2013, income taxes are scheduled to increase – for some taxpayers in higher tax brackets that increase will be substantial:

Tax item 2012* 2013*
Ordinary income 35% 43.4%
Dividends 15% 43.4%
Capital gains 15% 23.8%

Tax rates reflect highest marginal rate and incorporate additional taxes related to the health-care reform law. Health-care-related taxes include a surtax of 3.8% on net investment income and additional .9% payroll tax affecting single filers with income in excess of $200,000, and joint filers with income in excess of $250,000.

What strategies can clients consider in 2012 to capitalize on low tax rates while they’re still in place?

Accelerating income where feasible
Clients who expect to remain in higher tax brackets going forward may want to consider reporting more income on their tax return in 2012. This can be accomplished by:

  • Converting traditional IRA assets to a Roth IRA
  • Realizing more income from a business or partnership,
  • Exercising certain stock options.

Additionally, clients considering large financial transactions resulting in capital gains may wish to complete those transactions before 2013 to take advantage of the 15% tax rate. For example, the sale of appreciated stock, real estate, or a business. In addition to the maximum capital gains rate increasing to 20%, taxpayers in higher brackets may be subject to the new Medicare surtax on net investment income which imposes and additional 3.8% tax on those gains.

Accelerating tax deductions where feasible
With the return of income phaseouts on itemized deductions in 2013, clients in higher tax brackets should consider accelerating certain tax deductions into 2012 if possible. Examples include:

  • Prepaying mortgage interest
  • Prepaying local property taxes
  • Expediting elective medical procedures which may result in significant out-of-pocket expenses.

However, taxpayers should be aware that, if subject to AMT, some of these deductions will be reduced or negated (deduction for mortgage interest is still available if subject to AMT).

Making significant charitable gifts
Affluent clients considering gifts may wish to move forward in 2012 while generous tax benefits still exist. Given escalating federal budget deficits and increased costs for entitlement programs, the deduction for charitable giving has faced scrutiny from lawmakers. Additionally, it’s reasonable that the estate tax environment could be worse in the future as the federal government looks to generate more tax revenue, so removing assets from estates now may have advantages.

Limitations on charitable gift deductions

Type of gift Deduction†
Cash or equivalent 50% of AGI
Capital gain property 30% of AGI

† Assumes qualified, public charitable organization. Lower limits apply to other organizations such as private foundations.

Of course, with any potential moves affecting taxes, it’s critical for clients to work with a qualified tax professional.