As millions of Americans sit down to crunch out this year’s tax forms, they may want to start thinking about 2013.”Uncertainty” is the best way to describe 2012’s tax environment due to changing rules, deficit debates and election-year posturing.
Inflation’s upside We took a look at five trends that may have a big impact on the government’s bite in the months ahead:
Your 2012 taxes could benefit from what is usually a painful force of economics. There may actually be an upside to inflation.
By law, “the dollar amounts for a variety of tax provisions, affecting virtually every taxpayer, must be revised each year to keep pace with inflation,” according to the IRS.
The formula used in indexing showed a relatively higher amount of inflation this year over last, just over 3.8%, according to CCH, a Wolters Kluwer business and provider of tax information, software and services. This increase is well above the 1.4% amount used last year and the 0.18% inflation factor used in 2010.
“Most taxpayers benefit from inflation adjustments, since they tend to preserve the value of most, but not all, of the dollar-based benefits under the tax code year after year,” says George Jones, a CCH senior federal tax analyst.
The value of each personal and dependent exemption, available to most taxpayers, is $3,800, up $100 from 2011, according to the IRS.
The new standard deduction is $11,900 for married couples filing a joint return, up $300; $5,950 for singles and married individuals filing separately, up $150; and $8,700 for heads of household, up $200. Nearly two out of three taxpayers take the standard deduction, rather than itemizing deductions such as mortgage interest, charitable contributions and state and local taxes, the IRS says.
When there is inflation, indexing of brackets lowers tax bills by including more of people’s incomes in a lower bracket, an analysis by CCH explains.
Tax-bracket thresholds will increase for each filing status. For a married couple filing a joint return, for example, the taxable-income threshold separating the 15% bracket from the 25% bracket is $70,700, up from $69,000 in 2011.
CCH says to expect slightly higher standard deduction and personal exemption amounts for 2012 in most cases, as well as amounts that might be claimed from an increase in the income ceilings imposed on tax benefits such as education credits, individual retirement account contributions and more.
“Combined, inflation-based tax savings for 2012 can become substantial,” the CCH analysis says. “Because of inflation adjustments, a married couple filing jointly with a total taxable income of $100,000 should pay $190 less income taxes in 2012 than they will on the same income for 2011 because of indexing of their tax bracket for 2012. A single filer with taxable income of $50,000 should owe $95 less next year due to the adjustments to the income tax rate brackets between 2011 and 2012.”
“Not only is the top 35% rate bracket projected to rise from $379,150 to $388,350, but, as is the case for all individual taxpayers, the rise in the bracket amounts below the individual’s top marginal rate (that is, the incremental value of the 10%, 15%, 25%, 28%, and 33% brackets for someone in the 35% marginal rate bracket) also benefits the individual taxpayer,” CCH says. “As a result of the inflation adjustment in each of the brackets, someone filing a joint return with taxable income of $450,000 in 2012, for example, will pay $732 less in income taxes in 2012 than in 2011.”
Among the new inflation-adjusted tax figures for 2012 is the estate tax exemption. Previously set at $5 million, an inflation adjustment means that up to $5.1 million of an estate will be exempt from the current 35% tax.
Also increasing are contribution limits to most retirement savings plans — including 401(k), 403(b) and the federal Thrift Savings Plan — from $16,500 in 2011 to $17,000 (“catch-up” contribution limits for those 50 and older remain at $5,500).
You don’t tug on Superman’s cape. You don’t spit into the wind.
And, if you are a politician in an election year, you avoid anything other than sugarcoated tax discussions.
For months, Congress has punted any real discussion of taxes down the road, likely until after November’s presidential and state by state contests. A wide range of political stalemates and temporary compromises mean a whole lot of uncertainty for taxpayers in the year ahead.
“One common theme during 2011 for practitioners and taxpayers was the lack of certainty in tax planning for future years,” CCH Principal Tax Analyst Mark Luscombe says. “And that uncertainty was magnified by the scheduled expiration of many tax incentives after Dec. 31, 2011, and the end of the Bush-era tax cuts after 2012, due to extension by the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010.”
Will the payroll tax cut continue beyond its temporary stay of execution? What’s the fate of the Bush-era tax cuts (extended through 2012) and a variety of tax extenders? Will the maximum tax rate for capital gains increase to 20% from 15% or more if the Bush-era tax cuts expire?
Should the “rich” be taxed at a higher rate, a position taken by President Barack Obama and derided by conservatives?
Will there be changes to the personal exemption phase-out, something that would be a boon to wealthier Americans?
Are changes afoot for future implementations of the estate tax? CCH cites expert speculation that the current $5 exclusion will be lowered to $3.5 million and the top rate will rise to 45%.
Will deficit reduction talks — including the stalled response to the budget-cutting “Super Committee” — lead to increased revenue plays, a major point of division among Democrats and Republicans?
No one really knows, and we’ll all have to wait until November’s elections are in the history books to get a clear read.
An impact of all that uncertainty is that numerous tax strategies will be difficult to commit to in 2012. Income shifting in its many forms (deferred compensation, delaying year-end billings, maximizing retirement contributions, etc.) will be a gamble given that no one knows — or will know until late in the year — how taxes will rise or fall in 2013.
Big Brother is watching
Businesses and individuals alike should be prepared for increased scrutiny by the IRS in 2012 as the federal government, as well as states, look to increase collections as a means to bolster revenue.
A survey of 890 corporate tax executives released in November by KPMG, an audit, tax and advisory firm, found that nearly two-thirds (61%) of respondents said federal tax dispute activity had increased in the past 12 months, while more than one-third (37%) said the total number of state tax audits in jurisdictions in which they do business increased.
The majority of respondents expect this to continue. Over the next 12 months, 67% of the respondents said they expect federal tax dispute activity to increase; 53% expect the same on the state level.
“Federal, state and local governments are all taking extra measures to ensure that they are not leaving any corporate tax revenue on the table, as many are facing budget shortfalls,” Frank Lavadera, principal-in-charge of KPMG’s Tax Dispute Resolution Services Network, said in a statement. “Tax directors, CFOs and corporate boards should keep the increased likelihood of an audit by taxing authorities high on their priority lists, as it presents a significant tax risk. It is clear that taxing authorities are demanding greater transparency and imposing more complex reporting requirements, while the IRS and various states are adding tax audit personnel to increase the number of exams they can conduct.”
According to government statistics, IRS enforcement revenue increased by 18%, to $57.6 billion, and corporate examinations increased by 5% in fiscal year 2010.
The new year will also see a continued focus by federal officials on overseas accounts through new requirements for reporting foreign assets.
The taxman taketh
While big and broad tax changes remain uncertain, taxpayers will nevertheless start seeing a variety of exemptions pulled away, meaning that many will need to plan on paying more unless Congress decides to reinstate them retroactively.
According to the California Society of CPAs, 67 tax benefits were set to expire with 2011.
Two separate provisions affecting the alternative minimum tax will expire at the end of 2011 that together “saved 26 million middle-class Americans from the clutches of the dreaded alternative minimum tax,” the society said in a recent run-down of tax changes. For 2012 and future years, tax credits will offset the regular income tax, but not any alternative minimum tax.
Also, the temporarily patched exemptions for the alternative minimum tax may have come to an end in 2011. For 2012 and future years, the AMT exemption amounts will revert to a lower statutory amounts ranging from $22,500 to $45,000.
“This will result in more taxpayers being subject to the AMT, and will increase the adjustments for taxpayers already subject to the AMT,” the society says.
Barring the extension of a temporary reprieve, in 2012 the Social Security tax will revert to its regular rate of 12.4%, with half (6.2%) paid by employers and the other half (6.2%) paid by employees. Self-employed people pay the full 12.4% rate as part of the self-employment tax. A temporary rate reduction dropped the rate to 4.2% for employees and 10.4% for self-employed persons. House Republicans took a political hit last month when they were seen as OK with rejecting a two-month extension and talks about the long term in favour of letting the tax rate rise while holding only long-term talks.
The $2,500 maximum deduction for interest paid on student loans begins to phase out for married taxpayers filing joint returns at $125,000 and phases out completely at $155,000, an increase of $5,000 from the phase-out limits for tax year 2011. For single taxpayers, the phase-out remains at 2011 levels.
A $500 credit for energy-efficient home improvements (such as windows, insulation and heating systems) has expired. Also chopped: a state and local sales tax deduction; higher-education tuition and fees deductions, the deduction for student loan interest, teachers’ classroom expense deductions and mortgage insurance premium deductions.
Retirees can no longer make up to a $100,000 charitable contribution directly from their IRAs to avoid taking a distribution into taxable income.
A key bit of uncertainty for businesses in 2012 is what happens to health care reforms set in motion by the Patient Protection and Affordable Care Act of 2010.
If all goes according to schedule, there may be some clarity by the end of June, at which point the Supreme Court will render a decision in a case brought before it by the National Federation of Independent Business and 26 state attorneys general challenging the law’s constitutionality.
Among the items that could be affected is a credit for small-business employers who pay at least one-half the cost of health insurance coverage for their employees. If the law stands, it is still likely that the initiative will be altered.
In November, the Treasury Inspector General for Tax Administration issued a report that found that the volume of claims for the credit has been low despite IRS efforts to inform 4.4 million taxpayers who could potentially qualify for it. As of mid-May 2011, slightly more than 228,000 taxpayers had claimed the credit, for a total amount of more than $278 million. The Congressional Budget Office had estimated the credit would cost $37 billion over 10 years and that taxpayers would claim up to $2 billion of credit for tax year 2010.
In response, the IRS has announced plans to conduct focus groups to determine why the claim rate was so low and may take steps to better inform businesses and encourage participation. Congress and the IRS may propose an overhaul of the way the credit is implemented.
Also on the table (for all taxpayers) is a 3.8% Medicare tax on investment income that is slated to go into effect in 2013.
Small businesses will also be anxiously awaiting news on potential changes to the estate tax, with some advocates arguing that higher rates can be blamed for family-owned businesses forced into dissolution due to tax bills that arise because a deceased owner’s includes business assets.