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Key Income Tax Planning Ideas for 2012

This year presents an unprecedented opportunity for CPAs to differentiate their firm and services and show that they provide significant value to their clients by having all of their clients' financial planning needs in mind, including retirement, estate, tax, investment and insurance planning. With so many unknowns in 2013 compounded by an election year, clients need to take advantage of many financial planning avenues now to avoid missing crucial opportunities to protect their nest egg and increase their net worth. Listen to Bob Keebler as he discusses how CPAs can use this uncertain time to help their clients plan for the future.

Key Income Tax Planning Ideas for 2012

Robert S. Keebler, CPA, MST, DEP, Partner, Keebler & Associates, LLP. Bob is a 2007 recipient of the prestigious Distinguished Estate Planners award from the National Association of Estate Planning counsels. From 2003 to 2006, Bob was named by CPA Magazine as one of the top 100 most influential practitioners in the United States. He is the past Editor-in-Chief of CCH's magazine, Journal of Retirement Planning and a member of CCH's Financial and Estate Planning Advisory Board. His practice includes family wealth transfer and preservation planning, charitable giving, retirement distribution planning, and estate administration.  

This audio webcast was originally recorded May 31, 2012.


On behalf of the AICPA Personal Financial Planning Division, this is Bob Keebler and welcome to: Income Tax, Finding Ideas For 2012.

Today I'll be your host as we walk through a number of ideas that will help you and help your clients. We'll go through a 2012 income tax overview, what's changing, what's in the legislative hopper, and what may happen in the coming months. We'll also talk about the proactive things we should be doing to help our clients.

When you think about this, we have to have our arms around the 2012 income tax brackets: Where are we today? And where are we going? And we have to understand the impact of the super committee failure. There is nothing in the history of the last 24 months of the Congress that tells us anything good is going to happen as far as the democrats and republicans coming together for the good of the country. And in all likelihood, we will see rates go up on January 1, 2013.

This is very serious. And if you step back and you look at this: If President Obama is reelected, he is going to want to negotiate from a point of strength; and that is going to be to allow the tax cuts to expire and then negotiate back down instead of back up. So, we have to understand: What is going to happen and what does that mean?

If you look at your materials, you're going to quickly see we have a 10 percent, 15 percent, 25 to 28, 33 and 35 percent rate. There are six rates. And that's the 2012 rate. Now, the single rate is exactly half of the married rate; basically at the 10 and 15 percent rate. This year from a capital gain perspective, we still have a 10 percent rate. Which is something we're going to have to talk about because there's going to be a lot of discussion about harvesting capital gains. Not harvesting losses, but harvesting gains. And the paradigm on that is very unusual because it's a complete shattering of everything we've talked about since we were all collectively in college.

So, what we're looking at is: What do we do? And how do we minimize our clients' taxes in the next 12 to 18 months? The other thing we're going to look at is the ROI on selling early. There is a mathematical question which becomes: When do I sell? If I'm sitting on a $100,000 gain that I'm going to have to consume in 2013 or 2014, the question becomes: Do I consume that now and pay tax at 15 percent? Or do I wait and potentially pay taxes 28 percent or at 20 percent?

These are very hard questions. Now the good thing is, they're quantifiable. They are definitely quantifiable. And we can figure this out. We can minimize our risk. The other things that come into play are Roth conversions, accelerating the gains on ISO's and NSO's; looking at what to do with accrued interest. There are a lot of what we might perceive as basic things. But when you pull them all together, they are going to help you a great deal in helping your clients.

Now, let's think about 2012 versus 2013. I know you know this, but I'm going to be a little redundant. Today, my ordinary income tax rate for many clients will be 10 percent in 2013, jumps to 15. There are people in the 25 percent rate today that jumps to 28 percent. And for people in the 35 percent rate, that jumps to 39.6. There are people in the 25 percent rate today, that it jumps to 28 percent. And for people in the 35 percent rate, that jumps to 39.6.

Now the rest of the story. Today's capital gain rate at the bottom of the market is going to be basically zero percent. Steve Bigge, one of my partners, represents all these retired Proctor and Gamble engineers. And he has most of them, the vast majority of them are in a zero percent tax rate -- amazing. I mean, if you pay some Wisconsin rates, for those that haven't moved to Florida or Nevada; but they're in a zero percent federal rate. Now next year, that is going to jump to a 10 percent rate or an 8 percent rate if they've held the property for more than five years.

Also next year, we're going to see the 15 percent rate go up to 20. But we also have to deal with the 3.8 percent healthcare surtax. So, some of this healthcare surtax, of course, is going to turn on what the U.S. Supreme Court does with the healthcare bill. In all likelihood, it would be very unusual to see the entire bill defeated by the Supreme Court. In all likelihood, what we'll see is the individual mandate taken away. No one knows -- I can hardly classify myself as any type of Supreme Court scholar. But there's a lot of bright people on TV every night talking about this. But by the end June, like a month from now, we will know where the Supreme Court is going on this.

Now, the impact of the super committee failure on income tax. First of all, we're going to have a sunset of current law to pre-2001 law. This is not meant to be a comprehensive overview of every little detail. It's to give you the big picture. But we're going to see is we're going to see an increase in ordinary income tax rates and capital gains rates. There'll be some increases in Social Security taxes. There'll be a conversion of qualified dividends from long-term gain rate to the ordinary income rate.

Now think about this. I represent a gentleman. He has about $100,000 a year of dividends, and I've represented him for a long time. There was a point in time where those dividends were ordinary income. But today they're only taxed at 15 percent. He's about to experience an increase in those rates from today's 15 percent rate to tomorrow's 43.8 percent rate. Now, how do we get to that rate?

Let's think about where we are. We are at 15 percent today, but then we're going to go to 39.6. We're going to add 39.6 plus 3.8. You're suddenly going to come up to -- you know, you're going to be at 43.4 percent. It's going to get real ugly real fast. And that doesn't even count the fact that you're going to lose some of your itemized deductions because of the three percent scale back.

So, I think there's some very important things we have to take into account. One thing is for closely-held businesses. Your clients -- great grandma and great grandpa made a Ford dealership in 1918. They bought it directly from Mr. Ford. And they're in Kalamazoo, Michigan. They have $12 million worth of earnings and profits in there. And they come to you and they go: "You know, what do we do? Do we take out this $12 million of earnings and profits, potentially paying tax at only 15 percent? Or do we leave it in there, knowing that someday that tax rate is going to be closer to 45 percent?"

Those are great questions. There are no great answers, unfortunately. But these are the things we have to get ahead of. And what we have to do -- and let me make sure I'm very, very clear on this; this is what I've been doing with clients. Because we do not know where the law is going -- write this down -- we have to create pivot points. Okay? A pivot point is nothing more than: If this happens, this is what we're going to do. And if this happens, this is what we're going to do.

We have to have these contingency plans. Because simply there are not enough lawyers and CPA's to meet with every client that's going to need this kind of advice between the election and the end of the year. So we have to be ready. We have to be able to instead of having a two-hour strategic conversation with your client; you have to have your client ready so you can have a 20-minute telephone conversation and say: "This is what happened. This is what we agreed on. Do I have your permission to make this happen?"

Now, with dividends coming out of C-Corporations. I want you to imagine this. Okay? Your clients decide on December 28th to have Christmas together. They have a very nice holiday. And then somebody says: "Hey, we better take this $2 million out of the corporation. Otherwise, we're going to get beat up on taxes. State law or the bylaws or the articles require 15 days notice for a board meeting. And we don't have 15 days."

So really what we should be doing right now is getting with legal counsel and figuring out under the bylaws, articles of incorporation, under state law, whatever governs -- I don't care what governs -- but find out what governs and get ahead of that and have your meetings.

And get your meetings in place so the IRS can't come back and say: "No. You paid the dividend on December 28th, but your board meeting wasn't timely. We cannot respect the dividend. And we're going to have to charge you -- we're going to pretend like the dividend happened in 2013. And we're going to charge you the 2013 rates." That is going to get real ugly real fast. Be careful of that. There has not been a lot of discussion about that, but there will be. And we want to get ahead of it.

Now, the other thing we're going to look out for is there will be a decrease in deductible business expenditures, bonus depreciation, Section 179 deduction. Now quite frankly, we have to be careful of some of this because this is all tied into the economy. And it's so difficult to see in our globally economy how all this works together. And no one can properly perceive it. But we want to be very careful not to take away too many of these incentives.

We also have to look at the decrease in the popular rental tax credits, the educational expenses, child tax credits. And then again remember, as we move through this, there'll be a phase-out of itemized deductions, personal dependency exemptions. There are going to be some things that we have to pay very, very close attention to.

Now, let's show up into the income tax planning opportunities. This is the heart of it. There's a lot written by the services, as far as the professional services, on all the different rules that are going to change. But let's talk about what you need to do about the planning; things we can do something about.

Now, the number one thing on your radar screen should be gain harvesting. Okay? You represent Dr. and Mr. Jones. Dr. Jones was a very successful cosmetic dentist. Her husband was superintendent of schools. They have quite a bit of money. They're living on $200,000 a year. And of that 200,000; 150,000 of that comes from long-term capital gain. And the question becomes: Do they harvest those gains in 2012? Or do they wait until 2013? My guess is we should be ready to harvest those gains after the election.

Now there is a very, very practical problem with that. The practical problem with harvesting those gains after the election is they are going to be in a very, very long line of people that want to harvest gains. For a lot of our Proctor and Gamble clients, what we're going to do is we are going to buy put options; and we are going to sell call options. And we are going to be ready to get out of that stock in either December or January, depending on what's happening with rates. We should be very diligent on this.

Now, we'll also talk about that there will be instances where it makes sense to harvest losses. But we have to be careful though on the loss harvesting because think about this. If a long-term capital gain only costs you 15 cents on the dollar, but a short-term capital loss gives you a benefit of 43.4 percent on the dollar; you have to say to yourself: Does it really make sense to harvest that loss or should I wait? And these are the things we'll talk about.

Now, what we want to talk about in the gain harvesting is selling assets with long-term capital gains in 2012 and take advantage of these lower rates. First of all, stop right here. Remember how I said my partner, Steve Bigge, keeps some of his clients in that zero percent rate? Quite frankly, we're foolish if we do not at least fill up that zero percent rate with capital gains. If we're still in the 10 percent rate, at least do Roth conversions to the top of the 10 percent rate. And we'll come back more to that in a second.

Now once we sell, we're going to want to repurchase the same or similar assets. That is going to be very, very critical to this overall plan. And then later, we can sell the assets when we would normally have sold those. And we have to be able to figure out the trade off, the ROI. On the surface, it appears that taxpayers should always harvest capital gains. But wait a minute. Flash back. Go back to your cost accounting class, where you learned about opportunity cost.

And harvesting gains introduces this mathematical trade off between a lower tax rate state and the loss of deferral. The tax we pay today is lower but it is paid sooner. And so you need to determine a crossover point. And the way we wanted to look at this, and we wrote a calculator to do this -- and we'll talk more about that at the end, and that will be available to you; but one way to conceptualize this would be to use a return on investment approach.

Now, let's make this real simple. I'll take a blank piece of paper and draw a denominator and a numerator. And in the denominator of the equation, in the bottom of the equation, I'd like you to put $15,000. And in the numerator of the equation, take $23,800 minus 15,000; where you're going to come up with $8,800 divided by 15,000. And that is well over 50 percent.

What I'm saying is if you are going to have to harvest in 2013 anyway to live on, you are going to be very wise to harvest right after the election. And if you're worried about the market falling apart on you, you're going to lock in with puts and calls. Okay? You will buy put options and you will write call options to finance those puts. You will put yourself in a position where you are going to lock in your clients' goals. Okay? This is a very big thing. The return on investment is over 50 percent. But interestingly enough, the 50 percent risk and 50 percent after taxes. Where else are we going to earn that with that level of risk?

Now, let's look at the factual situation. Taxpayer owns X,Y,Z stock; he has held for many years on a basis of $50,000 and a fair market value of a hundred. So, he has a built-in gain of $50,000. Taxpayer's rate on long-term capital gains this year is 15 percent; and it's 23.8 percent in 2013. Your client sells stock in 2012, recognizing a long-term capital gain of $50,000; he's paying tax of 7,500. So, 50,000 times 15 percent gets us to the 7,500. Taxpayer then repurchases the stock the following day. The stock grows at five percent a year. Hence, taxpayer sells the repurchased stock at some future date.

I put together a chart. And here's what that chart basically says. Based upon these parameters, in a one-year period of time, the ROI on this is 54 percent. In a three-year period of time, the ROI is still 13 percent. And in a five-year period of time, we're still earning on an after-tax risk free basis, 6.59 percent. These are incredible returns considering the lack of risk. Okay? So, we really want to be diligent. Make sure we alert our clients. And we will come out with some kind of letter that's going to help you explain this to your clients.

Now, let's go through some rules of thumb. Here's the problem with these rules of thumb. And I recognize that all of you know this. Okay. You're all very smart. But every client that comes to see you brings with them a mosaic of 40 or 50 years of adult financial life behind them. And if they have a very short-term time horizon -- in other words, they're going to sell next year; by all means you should sell now. If they have a very long-term time horizon -- they're 55-years-old and they're not going to retire until they're 70; then there's probably very little sense in playing this game.

If the taxpayer is in the zero percent long-term bracket of 2012, they're almost always going to benefit by selling now, paying tax at zero percent; and then re-buying and getting that nice, clean step-up basis. And this is all statutorily allowed. I mean, this is not one of these son-of-boss transactions where we're playing with all kinds of pieces and gluing pruned sections together that were never intended to be glued together. These are legitimate transactions.

Now, the other thing we have to be worried about is taxpayers that are going to die. There was just a lady in our paper here yesterday, and I had met her a couple of times; but she died at 102 years old. And wow. If you represented her, I think you'd be wise to say: "I'm not going to harvest any gains early. I'm just going to hang around and to see what happens." If you have realized loss carryovers from prior years, keep in mind: What is the value of those losses carry forwards? You may not want to use long-term capital loss carry forwards in an inefficient way. Okay?

Now, on page 16: Acceleration of income into 2011 and 12. Basically, let's talk about the sale of bonds with accrued interest. I come to you in December and I say: "You know, in January I'm going to be picking up $100,000 of investment income. And what can I do to bring that into 2012? Because if I bring it into this year, I'm going to pay tax at 35 percent. If I have to wait till next year, I'm going to be at over 43 percent. And you know, it's going to get real ugly real fast; 43.4, adjustment for itemized deductions. I'm going to be close to 45 percent."

You might say to me: "Well, Bob, here's the plan. What we'll do is we will sell those bonds towards the end of the year." I know you know the rule, but let's just re-emphasize this: When I own a bond and that interest is being accrued, and it's almost ripe; if I sell the bond, I have to pick up that income on my final 1040. I shouldn't say my final 1040. I can pick it up on my 1040 for 2012. So, I picked it up. I report the income. And then if I later re-buy the bond, I'll get that purchase money interest, which later I'll pick up as a contra expense in the next year.

Other alternative investments that are out there. What's happening? Literally -- and I mean, I know you know this, people -- the stock market for the last 10 years has been flat. Not many people are missing that any more. And that's driving people into oil and gas investments, gold investments, foreign currency investments, index options. We as CPA's, advising these clients, have to be all over these things. Keep in mind, we want to accelerate income -- bond income, annuity income, traditional IRA income, Roth conversion income, compensation income -- into 2012; very critical to our overall plan. Okay? So, we have to make sure we're bringing that into our 2012. I think that's so important because you're going to save about eight percent by doing that.

Now the other thing is: Make sure that if you have bonds with accrued interest, you can at least take a look at selling those. Because I believe that through very, very little effort -- let's say I had $100,000 worth of accrued interest; I sell those bonds this year; I pay $35,000 of tax. Not a fun event. But on the other hand, if I waited till next year, my tax rate would be $39,600. If I waited till the surtax comes around, if I get stuck in the surtax, my rate is suddenly closer to 45 percent when we take into account the loss of itemized deductions. So, Bernie Kantor wrote about this. I think it's an article worth reading. These are important things that you want to look at.

Now, the other thing you can do and this gets a little tricky; but with interest rates going down in value, there are a lot of bonds that are trading at a premium. And the game is you sell those bonds that are trading at a premium; we pick up a capital gain because that is a market increase in value; and we pick up a capital gain. We might even be able to offset that with the capital loss carry forwards; but then we re-buy a very similar bond and we're able to amortize that bond over a period of time.

So, we're able to amortize that bond over a period of time. That becomes very important. And we believe the savings there can be tremendous. Roughly, for every $100,000 involved, if you have this situation; you can save about $12,300. So, you can see there's a lot going on here. These are things that you're definitely going to want to embrace and look at which clients they apply to. Okay.

 Now, one thing that is in the President' plan. The President would like to do away with some of the incentives associated with oil and gas investments. Now from a policy standpoint, I think most reasonable people would say: "Does that make sense?" And it may not make sense. But it is what it is. And we could lose some of those IDC's and tangible drilling costs. And basically what you're allowed to do, and I've done this myself: If I invest a dollar in an oil and gas deal, I get a deduction up front of about 85 percent. But then when income starts coming out of the investment, I am allowed to take a depletion deduction. And the depletion deduction further shelters my cash flow. I'm also getting 179 deductions. These are good deals from a tax perspective.

Now the problem is at $2 an MCF, natural gas does not look very good right now. What they're doing right now is they're liquefying gas. And they're going to be able to put that in super tankers and send that all over the world. That may help the price coming forward. But those are investment issues for you to discuss with your clients as investment advisors.

But all is not lost. Now, oil remains a very good investment because of the high prices. Okay? Now, if you look at gold investments. Very quickly, what we want to know is -- remember, two things in gold: 28 percent capital gains rate and the wash sale rules do not apply to gold. Okay? The wash sale rules do not apply to gold. Finally, foreign currency transactions. Again, you want to look at: Can you recognize any of your losses on your foreign currency transactions, bring those into 2012? And the other big issue is: Sometimes when you have losses, does it pay to harvest those losses in 2012 -- some of this thinking is counter-intuitive -- or do we wait until 2013?

So, we've covered a lot of ground. This was meant to get you started. There is so much you can do for your clients. The AICPA has done a ton of work. Under Andrea Millar's leadership, there is a lot out there to help you help your clients. Our goal is to allow you to spend more time with your clients instead of more time inventing products and coming up with ways to explain things.

To help you help your clients, the AICPA has created a toolkit with in-depth planning techniques, plot communication tools, a gain harvesting return on investment calculator, and much more: Preparing Your Client for the 2013 Tax Increases: Tools, Tips & Tactics. The overall goal here is to allow you to service your clients while the AICPA provides you with hard-hitting material so you can easily explain to your clients these concepts.

2012 will be a difficult year. And by using this material, you'll be able to shortcut the amount of time you spend in the back office and increase the amount of time you spend with clients. PFP-sanctioned members can purchase the toolkit for 50 percent off the regular price or $59. Also visit AICPA.org/PFP/ProactivePlanning for more resources.

On behalf of the AICPA, this has been Bob Keebler, and thank you for joining us today.


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