The people have spoken, and taxes are going up.

November 7th, 2012 by Joe Kristan

The President gets another four years.  What can we expect for tax policy?  My initial thoughts, in order of certainty:

The new Obamacare taxes are going to happen.  The 3.8% tax on “investment income” will take effect in 2013 as scheduled, as will the .9% increase in Medicare withholding on high-salary employees.  That means taxpayers have to make some important decisions on how they group their business activities to minimize their “passive” income.  Taxpayers whose involvment in activities isn’t clearly “active” need to start carefully documenting their time to support their non-passive status. 

There will be an AMT Patch.  This is the only big piece of tax legislation that I think is likely to pass the lame-duck Congress.  It is likely to drag along most of the usual expiring provisions, like the research credit and the wind energy credit.

The top individual rates are going up.  Will they go all the way to the 39.6% rate?  That depends on what deal the Republican House can cut; the president wants the lower-bracket Bush-era cuts to remain in place, but not the top rate cuts.  I suspect the president won’t blink like he has before, and at best the Republicans will save face by keeping the rates from going all the way off.  They may not even get that.  I really hope I’m wrong.

Capital Gain Rates will go up.  23.8% is coming — 20% regular rate, 3.8% Obamacare rate.

Dividend Rates will go up.  The only question — will it be the 23.8% capital gain rate or the 43.4% ordinary income rate? 

What does it mean for planning? 

  • Turn the usual planning around.  If you are affected by the higher rates, this is the year to accelerate income and defer deductions.   It makes no sense to delay income just to pay a higher rate.  Deductions are worth more next year.
  • Rethink your depreciation and Sec. 179 decisions.  While it’s nice to get a big deduction this year, those depreciation deductions are likely to save you more over the next five or seven years than the present value they provide today at a lower rate.
  • Consider a dividend purge.  If you have an S corporation with dividends, or have some built-up earnings in a closely-held C corporation, this might be the year to take that dividend distribution.  15% is a lot less painful than 23.%, or 39.6%.
  • Big gifts should be completed before year-end, if you are so inclined.  If you have a high enough net worth where you can use it, you should.  The lifetime exemption is unlikely to be higher than $3.5 million after this year, and may be as low as $1 million.
  • Stay flexible.  Watch what the lame-duck Congress does.  Get ready to pull the trigger, but don’t commit before you have to.  Stay in touch with your tax pro.

C corporation planning doesn’t change much, other than the dividend thing.  Their rates won’t change, so the usual incentives to defer income and accelerate deductions still apply.