What Difference Does a Day Make?

Joe Popp | December 19th, 2012

How do you plan for an uncertain future?  Very carefully.  That’s the advice that we’re giving to our clients as they to prepare for the tax law changes that are coming on January 1, 2013.

We can’t see into the future, but it looks like rates will go up, on lots of different types of income, in 2013.  Unless changes happen, your rates will be significantly higher on January 1 than on December 31.  What difference does a day make?  Perhaps as much as a 29.4 percentage point jump in your taxes.

Why the big change?  Two reasons:

  • The Bush tax cuts are set to expire at the end of the year.  Originally passed in 2001, these cuts reduced rates for all taxpayers, cutting the top tax rate from 39.6% to 35%.  The rate reductions have a built in sunset provision – without Congressional action to extent them, the rate reductions disappear at the stroke of midnight on December 31st, 2012.  Itemized deductions will also again be limited for high income earners, adding another hidden 1% tax on taxpayers who are hit by the limitation.
  • New Obamacare surtaxes start in 2013.  There are a number of healthcare related surtaxes that kick in on January 1.  These surtaxes apply to high income wage earners and people with high investment income.  This includes a new 0.9% tax on earned income over $250,000 (married filing jointly) and a new 3.8% tax on investment income for married filing jointly taxpayers with total income over $250,000.

2012 Year-End Tax Planning

Traditional year-end tax planning has focused on tax savings through timing differences.  The standard advice has been to accelerate deductions and defer income so as to maximize your savings from the time value of money.  So if you got to save paying $1 of tax now, next year that dollar is worth $1.05 (assuming you invest it) – you still pay the $1 in tax but you get to keep that extra 5 cents.   This assumes a 5% rate of return.

But, this year’s rate increases are permanent tax rate differences.  The rate differentials (less tax this year than next year) range from around 5% for wage income, to 9.4% for interest income, and 29.4% on dividend income.  As you can see, depending on the type of income you have, you can save a lot more money by accelerating income this year than by relying on the time value of money savings.

Accelerate Income and Defer Deductions

How do you accelerate income?  One easy way is to harvest gains in 2012 by selling appreciated assets before the end of the year.  Sell them before the end of the year and you’ll pay a lower percentage of tax on the gains than you would in 2013.  Conversely, you can defer deductions by waiting to sell those assets that have depreciated.  The write off you’ll get from the loss will be worth more in 2013 than it would be today.

Right now, the cost savings from the rate difference may save you more than the time value of money.  Of course, the miraculous could happen.  Congress could reach an agreement, avert the fiscal cliff, and keep rates low.  If that does happen and the rates are changed to stay the same, accelerating income to this year will result in you paying more (you would lose the time value of money savings).

Ohio Tax Planning Help

Without a crystal ball to gaze into, we can’t know for sure what will become of the fiscal cliff and how it will impact tax rates.  So, we’re recommending a prudent and proactive approach to tax planning.  Year-end tax planning is always important, but this year more so than ever.  If you haven’t yet done so, call your tax adviser (today!) to discuss your year-end tax strategy.  Hurry up and contact Rea & Associates for 2012 year end tax planning help.

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