Are You Headed Over the ‘Fiscal Cliff’?

November 13, 2012

You have certainly heard the news coverage of the so-called “fiscal cliff” coming at the end of this year.

Basically, many provisions in our federal income tax system have an expiration date of Dec. 31, 2012, by design. Without corrective action by our legislators, many negative tax changes will automatically happen.

Among its effects are:

• An increase in marginal income taxes for most taxpayers
• An increase in long-term capital gains rates
• The expiration of the special tax benefits of certain corporate dividends

But the key question is – are you prepared to act on this?

Here are some ways to minimize the cliff’s effect on your financial affairs:

• If you have unrealized long-term capital gain assets in your portfolio, are you prepared to sell them to lock in the current 15 percent federal rate?
• Consult with your financial adviser as to whether your business is still in the best tax entity for your specific situation.
• If you have sold property this year under the installment method, have you considered electing to tax all of the proceeds this year? You have until your return is filed next year to make such a decision, but start thinking about it, and planning for it, now.
• If you have been thinking about major wealth transfers to your descendants, 2012 is an excellent year to do so while there is a $5.12 million cumulative exemption from federal transfer taxes.
• Have you been considering a Roth conversion of your IRA? If so, 2012 may be the last and best year to do so, given lower tax rates this year and the 2013 imposition of a new Medicare surtax on investment income.
• If your business is a C corporation, or an S corporation that was previously a C corporation, ask your tax adviser if you have earnings and profits inside your corporation. Do you want to pay that out in 2012 while you can do so at a 15 percent federal rate? It might cost as much as 45 percent in federal tax in 2013, after the higher marginal rates, Medicare surtax on investment income, and phased-out itemized deductions and exemptions.

Be on the lookout for news developments on remedies for the fiscal cliff, and watch for updates from your CPA firm. There is no way to know whether these changes will be prevented through legislation or when such changes will be effective.

So stay alert. And, with the advice of your tax adviser, be prepared to act – perhaps with very little notice.

This tax tip contributed by:

R. Milton Howell, III
Partner 
Davenport, Marvin, Joyce & Co., LLP