Tax Planning in the Wake of "Status Quo" Election
(Parker's Federal Tax Bulletin: November 9, 2012)

Washington, D.C. - To provide tax practitioners with some clarity in a hazy post-election environment, the AICPA offered presentations by some of the nation's top legislative analysts at its Federal Tax Conference on November 7-8.

Perhaps the most informative address was delivered by Don Longano, a principal at PwC responsible for analyzing federal tax legislation. Longano provided insights into what practitioners can expect as a result of the reelection of President Obama and the continuation of the current majorities in the House and Senate.

Fiscal Cliff Looms

Probably the biggest challenge facing the President and Congress is the "fiscal cliff." This refers to three big fiscal policy deadlines that require some action in the near future. First, there is the "sequestration." The sequestration mandates large across-the-board discretionary spending cuts, affecting both defense and entitlement programs, unless Congress reaches a budget agreement. The cuts are set to go into effect on January 3, 2013. The second is the federal debt limit which will be reached in late 2012, according to some estimates, and will require bi-partisan Congressional action. And finally, funding for the government expires on May 27, 2013, which will also require bi-partisan Congressional action.

According to Longano and other speakers, if the sequestration happens, the country will be thrown into a recession. Keeping the country on the road to recovery while paying down the country's debt is a delicate balancing act, and it's unclear, given the election results, how the fiscal cliff will be resolved.

Expiration of 2001-2003 Tax Cuts and Payroll Tax Relief

Also on the front burner is whether or not to let the 2001-2003 tax cuts expire. In Longano's opinion, the Administration will likely let the cuts expire, thus increasing everyone's tax rate. Then a proposal would be put forth to lower the tax rates on individuals making less than a certain amount, maybe $250,000. This could work, he said, because no action would be required to let the 2001-2003 tax cuts expire, and "new" tax cuts are generally popular and easy to pass. There seemed, however, to be a consensus among speakers that there is little appetite in Washington for extending the payroll tax relief that was in effect for 2011 and 2012.

Expiration of Favorable Estate and Gift Tax Rates and Exemptions

There is also the issue of the expiration at the end of 2012 of favorable estate, gift, and generation skipping transfer tax rates and exemptions. Unless Congress enacts another change, those rates will revert to the rates in effect before the enactment of the 2001 tax law. Under those rules, a single graduated rate schedule with a top rate of 55 percent and a single effective exemption amount of $1 million would apply for purposes of determining the tax on cumulative taxable transfers by lifetime gift or bequest. However, the Administration has proposed making permanent the estate tax rules as in effect in 2009. In that case, the top tax rate would be 45 percent and the exemption amount would be $3.5 million for estate and generation skipping transfer taxes, and $1 million for gift taxes. Regardless, it would seem prudent to have clients in this position consider making large gifts in 2012 to use some or all of the larger exemption amounts currently in effect.

PPACA Implementation

Because this was a "status quo" election, there is no mandate to repeal the Affordable Care Act. The controversial law has effectively cleared the last hurdle to full implementation. Thus, two new taxes on high income individuals (the .9% and 3.8% so-called "Medicare" taxes) will go into effect on January 1, 2013, as scheduled.

AMT Patch

With respect to the AMT patch that expired in 2011, it is expected that Congress will cobble something together for the 2012 tax year. If Congress ever enacted real tax reform, taxpayers wouldn't need the AMT patch. But this is unlikely to happen in the near future. Thus, the AMT patch has to be one of Congress' top priorities. Speaking on Wednesday, IRS Commissioner Douglas Shulman noted that IRS forms already take into account that an AMT patch will be enacted. If that does not happen, there could be a big delay in releasing the 2012 tax forms according to Shulman.

Increased Rates on Capital Gains and Dividend Income

In addition to losing the low tax rates on ordinary income put into place in 2001-2003, tax rates are also scheduled to go up on capital gains and dividend income. For anyone who is expected to be subject to increased rates on dividend income or capital gains, including the 3.8 percent Medicare tax on investment income, Longano and other speakers recommended that such clients harvest investment gains now while the tax rates are low. Beginning in 2013, the 3.8 percent Medicare tax applies to the lesser of (1) net investment income; or (2) the excess of modified adjusted gross income over a threshold amount. The threshold amount is $250,000 in the case of individuals filing a joint return or a surviving spouse, $125,000 in the case of a married individual filing a separate return, and $200,000 in any other case.

The Administration's Proposals

Some of the Administration's proposals for FY13 (October 1, 2012 - September 30, 2013) that are considered to have a chance of moving forward as part of a larger tax reform bill include the following:

1. A reduction in the corporate tax rate from 35 percent to 28 percent, fully offset with base-
    broadening options

2. Expanding and making permanent the research and development credit

3. An increase in the Section 199 deduction for domestic manufacturing to 10.7 percent to provide a
    25 percent rate for certain domestic manufacturing income

4. A minimum tax on foreign profits

5. Permanently extending AMT relief

6. Freezing the estate tax at 2012 levels

7. Reducing the value of certain deductions by limiting them to a 28 percent rate.

Five-Year Cost of Existing Deductions

The Joint Committee on Taxation has released a schedule showing the cost to the Treasury (in billions of dollars) of certain deductions over a five-year period, including the following:

- Exclusion of pension contributions and earnings ($933.7)

- Exclusion for employer-provided health care ($725.0)

- Mortgage interest deduction ($464.1)

- Reduced rates on capital gains and dividends ($456.7)

- Exclusion from tax of Medicare benefits ($347)

- Earned income tax credit ($294.1)

- Deduction for state and local income taxes, sales, and property taxes ($230.3)

- Deduction for charitable contributions ($228.4)

Conclusion

In conclusion, Longano noted that the fiscal situation is so complicated and has so many moving pieces, that it's unrealistic to expect any major tax reform immediately. He believes that by late December, Congress and the President will somehow enact short-term tax relief, including an AMT patch. But in the long term, taxpayers should expect that, if there are tax rate reductions, they will be accompanied by base broadening measures.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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