Jon P. Karp, CPA, PFS Whitley Penn, LLP 8343 Douglas Avenue, Suite 400 Dallas, TX 75225 Direct: (214) 393-9400 Main: (214) 393-9300 Fax: (214) 393-9401 Email: [email protected]Income Tax Planning Strategies for 2012 Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication, including attachments, was not written to be used and cannot be used for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein. If you would like a written opinion upon which you can rely for the purpose of avoiding penalties, please contact us.
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Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication, including attachments, was not written to be used and cannot be used for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein. If you would like a written opinion upon which you can rely for the purpose of avoiding penalties, please contact us.
• Very short time horizon– Gain harvesting will almost always be favorable because the benefit of tax deferral is small
• Very long time horizon– Gain harvesting will almost always be unfavorable because the benefit of tax deferral is large
• Taxpayer in the 0% long-term capital gains bracket in 2012– Gain harvesting will always be favorable from a tax perspective because it gives you a free
basis step up• Taxpayer plans to die with assets and pass them on to heirs with a stepped-up basis
– Gain harvesting unfavorable because any gain would have been wiped out at death • Taxpayer has realized loss carryovers from prior years
– Losses would be better used to offset gains in later years when long-term capital gains rates are higher
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Should You Harvest Gains?More Difficult Fact Patterns
• In many cases, the answer will not be clear without doing a ROI calculation
• Use AICPA software
• Decision Rule: • Harvest gains when ROI > opportunity cost of capital
• Opportunity Cost of Capital– What rate of return could you have expected if you had invested the money
used to pay the 2012 tax in an alternative investment with comparable risk?
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Gain Harvesting--Caveat
• IRS might try to apply the economic substance doctrine (IRC § 7701(o))
• 20% penalty if sale/repurchase lacks economic substance• 40% if transaction not reported on tax return• Penalty might apply if you repurchased the same asset
immediately after the gain harvesting sale• Safer to repurchase assets that are similar but not identical, leave
the sale proceeds in cash and/or put a significant amount of time between the sale and repurchase
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Accelerating Income to 2012
• Certain types of ordinary income can be accelerated into 2012:
– Bond interest– Annuity income– Traditional IRA income– Compensation income– Stock options– Roth Conversions
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Accelerating Interest Income--Example
Art is current in the 35% ordinary income tax bracketOn December 22, 2012, he has $100,000 of accrued bond interest that will be paid on 1/3/2013.Art sells the bonds at par on that date, paying $35,000 in taxIf Art had waited until 2013 to recognize the interest income he would have paid tax at a 43.4% rate (counting the surtax)Thus, the interest harvesting strategy saves Art $8,400 ($43,400 - $35,000)
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3.8% Medicare Surtax
• Imposed on individuals, trusts and estates for tax years beginning on and after January 31, 2013
• Applies to the lesser of:– Net investment income (NII), or– MAGI over an applicable threshold amount (ATA)
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Net Investment Income
• Included items– Interest– Dividends – Rents– Annuities– Capital gains– Royalties– Passive activity income
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Net Investment Income
• Items specifically excluded– Self-employment income– Non-resident aliens– Active Trade or business income– Gain on the sale of an active interest in partnership or
S corporation– IRA or qualified plan distributions– Trusts for charity (except Charitable lead trusts)
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MAGI
• Amount reported at bottom of page 1, Form 1040 (AGI)
• + net amount excluded as foreign earned income under section 911(a)(1)
• For most taxpayers it is the same as AGI
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3.8% Surtax -Example
• Warren, a single taxpayer, has $170,000 of investment income and received a $65,000 required minimum distribution (RMD) from his traditional IRA in 2013.
• The RMD is not NII, but it is included in MAGI, increasing it to $235,000
• The surtax applies to the lesser of NII ($170,000) or the excess of MAGI over the $200,000 threshold amount for single taxpayers ($35,000).
• Thus, $35,000 is subject to the surtax and the amount payable is $1,330 (.038 x $35,000).
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Applicable Threshold Amounts
• Married taxpayers filing jointly...........$250,000
• Married taxpayers filing separately....$125,000
• All other individual taxpayers.............$200,000
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Minimizing the Surtax
• Strategies to reduce net investment income--
– Tax exempt bonds– Tax deferred annuities– Life insurance– Rental real estate– oil and gas investments– choice of accounting year for trusts and estates– timing of estate and trust distributions
• Strategies to reduce MAGI--
– Roth IRA conversions– charitable remainder trusts– charitable lead trusts– Installment sales– above-the-line deductions
Climbing back up23
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Circular 230 Disclosure
Pursuant to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, nothing contained in this communication was intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose. No one, without our express prior written permission, may use or refer to any tax advice in this communication in promoting, marketing, or recommending a partnership or other entity, investment plan or arrangement to any other party.
For discussion purposes only. This work is intended to provide general information about the tax and other laws applicable to retirement benefits. The author, his firm or anyone forwarding or reproducing this work shall have neither liability nor responsibility to any person or entity with respect to any loss or damage caused, or alleged to be caused, directly or indirectly by the information contained in this work. This work does not represent tax, accounting, or legal advice. The individual taxpayer is advised to and should rely on their own advisors.