Tax Planning for the Fiscal Cliff and Beyond- Business and Individual Planning

The holidays will soon be behind us and the new-year-new-you weight-loss ads will start to appear. That means it’s time to begin thinking – and planning – for year-end tax strategies to minimize the April 15th tax bite.

Traditional tax-reduction strategies for businesses include buying new equipment or computers that you can write off quickly, paying bills before year’s end (for those on the cash basis), awarding holiday bonuses to valued employees and setting aside funds for the retirement plan.

But tax planning this year might be a bit different. That’s because of the ongoing tax and spending stalemate in Washington. Known as the fiscal cliff, it refers to a package of Bush-era tax cuts slated to expire after 2012 and two new Medicare taxes targeting higher income taxpayers beginning in 2013. As a result, your deductions may be far more valuable next year.

As Congress and the White House continue to debate the fate of 2013 income taxes, here is what we expect will happen once the dust settles:

Marginal (Ordinary Income) Tax Rates

The marginal tax rate is the rate at which your last dollar of income is taxed. Currently, marginal tax rates range from 10% to 35%. However, it is expected that the tax rules will eventually incorporate marginal rates of 36% and 39.6% on income over $250,000. These rates could become effective as soon as next year.

Capital Gains Rate

The tax rate that applies to long-term capital gains is currently 15%. Expect that rate to increase to 20% beginning in 2013. Most capital gains will also be subject to a new Medicare surtax on investment income discussed below.

Qualified Dividends Rate

Since 2003, dividend income has been taxed at a preferential rate identical to long-term capital gains. Many believe that dividend income will be taxed as ordinary income subject to the taxpayer’s effective marginal tax rate. That means an expected increase from 15% to as high as 39.6%. These dividends may also be subject to the new Medicare surtax on investments.

Medicare Surtaxes

A new Medicare tax of 3.8% that applies to the investment income of higher-income taxpayers could push the Federal tax on interest, dividends and other investment income over 40%.

Single taxpayers making $200,000 or more and married taxpayers making $250,000 or more are subject to this new tax beginning next year. Additionally, a new wage surtax of 0.9% targets wages over $200,000 ($250,000 for married taxpayers).

Itemized Deductions

Finally, lawmakers are also reviewing proposals to limit the deductions of higher income taxpayers as a way of broadening the income tax base. This limitation may take the form of a fixed percentage (one proposal limits the itemized deductions for high income taxpayers to 28% of income) or a fixed amount (another proposal limits itemized deductions to $50,000).

While it still may make sense to defer income and accelerate deductions, consider doing the opposite in order to achieve the greatest tax savings over time. Seek the advice of a skilled tax advisor to design and implement the best financial strategy to ensure the long-term health of you and your business.

Whether Uncle Sam falls over the cliff or is stopped short, you still need to start planning today.

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