Dividends may lose tax-favored status in 2013

(Editor’s note: This is the final installment in a three-part series on tax-planning considerations and strategies for tax-year 2012.)

Since 2003, investments that have produced “qualified” dividends generally have been more attractive than other income investments because such dividends are taxed at long-term capital gains rates. Interest from taxable bonds, money- market accounts and certificates of deposit, on the other hand, is taxed at higher, ordinary income rates.
But the appeal of dividends might change in 2013 because qualified dividends might once again be taxed at ordinary income rates for some or all taxpayers.
The new 3.8 percent Medicare tax on investment income also would apply to dividends to the extent that MAGI exceeds the applicable $125,000, $200,000, $225,000 or $250,000 level.
Again, keep an eye on the election and Congress. If it looks like no action is going to be taken to extend qualified-dividend tax treatment to 2013, or like such treatment won’t be extended for your income level, you may want to revisit your asset allocation and sell some dividend-producing investments by year end. You might also benefit from locking in a lower long-term capital gains tax rate and avoiding the additional 3.8 percent Medicare tax. Of course, you first must consider your investment objectives; dividend-paying stock may be attractive even without the tax-favored status.
Expired and expiring tax breaks
Numerous tax breaks expired at the end of 2011 or are scheduled to expire at the end of 2012. Here are just a few that may be relevant to you:
Expired Dec. 31, 2011:
• State and local sales tax deduction in lieu of state and local income tax deduction.
• Direct, tax-free donation to charity from an IRA (up to $100,000) by taxpayers age 70½ or older. Scheduled to expire Dec. 31, 2012:
• Repeal of income-based phase-outs on itemized deductions and personal exemptions.
• Coverdell Education Savings Account (ESA) $2,000 contribution limit and tax-free distributions for elementary and secondary education expenses – limit will be reduced to $500 and only distributions used for qualified postsecondary education expenses will be tax-free.
It’s important to work with your tax adviser to determine which ones affect you and to monitor whether any legislation passes before year end.
The results of the election should shed some light on what Congress will try to accomplish in the “lame-duck session” that starts in November – and what they’ll put off to next year. (In terms of the latter, tax-law changes could be made retroactive.) If President Barack Obama is re-elected, Republican leadership might be more likely to strike an agreement with Democrats on the substance of extending tax cuts and there could be a greater chance of tax legislation being passed before year end. If former Gov. Mitt Romney is elected, Republicans might have less reason to compromise and there could be a greater chance that tax legislation wouldn’t be passed until after the inauguration in late January.
Other election results will also affect legislative action. One is which party will control the Senate and by what margin. As for the House, the Republicans are expected to retain control, but also significant will be how many of the Tea Party members elected two years ago retain their seats.
Given that the House and the Senate will return only briefly after the Nov. 6 elections before recessing again for Thanksgiving, there’s a good chance that the soonest any meaningful tax legislation could be passed would be December, not leaving much time to implement year-end tax planning strategies. Be prepared
We’ve only touched the surface of the potential impact of various tax-law change scenarios on your year-end tax planning. If you’re a business owner, you also need to carefully consider business-related tax breaks as well as the impact of your business’s structure on tax planning.
And everyone needs to think about their estate-planning strategies, because gift, estate and generation-skipping transfer (GST) taxes will increase significantly in 2013 if Congress doesn’t take action. President Barack Obama has proposed a return to a $3.5 million exemption and 45 percent top rate, while Gov. Romney has proposed repealing the estate tax.
To be prepared for any situation, it’s a good idea for you and your tax adviser to review your year-to-date income, deductions, gains and losses and project what these amounts may be in 2013. You can then use this information as the 2013 tax landscape becomes clearer to quickly decide what steps to take by year end to achieve your goals. •


Grafton “Cap” Willey, CPA, is a managing director in the Tax Group at CBIZ Tofias. He can be reached at GWilley@cbiztofias.com. CBIZ Tofias (www.cbiztofias.com) is a leading accounting provider with offices nationwide including Providence, Newport, Boston and New Bedford. The company operates in association with Mayer Hoffman McCann P.C. – Tofias New England Division, an independent CPA firm that delivers audit and other attest services. Together the companies rank as the 7th-largest accounting provider in the U.S.

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