Sunset Provisions: Business and Investment

Many of the “Bush-era” tax cuts are scheduled to sunset at the end of 2012. The “Bush-era” tax cuts is the collective term for the tax measures enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). These two Acts made changes to over 50 provisions of the Internal Revenue Code and impacted a wide variety of taxpayers. However, in order to comply with budget requirements, the changes are scheduled to expire. In a presidential election year, it is not clear what, if anything, Congress will do to extend these tax cuts. This uncertainty in the tax law generates a myriad of complexities for taxpayers and tax professionals.

The following are highlights of some of the business and investment tax cuts scheduled to expire after 2012 and what might happen if they are not extended.

Capital Gains

The reduced maximum capital gains rate of 15 percent on adjusted net capital gain of noncorporate taxpayers and the zero percent capital gains rate on adjusted net capital gain of noncorporate taxpayers in the 10-percent and 15-percent income tax bracket are scheduled to expire for tax years beginning after December 31, 2012.

Impact – Absent extension, the maximum tax rate on net capital gain of noncorporate taxpayers will revert to 20 percent (10 percent for taxpayers in the 15 percent bracket) after 2012. Thus, the acceleration of the sale of capital assets into 2012 while the tax rates are lower is one strategy for taxpayers to consider. As long as the sale is bona fide, and the proceeds are received in 2012, capital gains can be accelerated. The “wash sale” rules that apply to claiming losses do not apply to gains. Accordingly, capital gains can be recognized at any time and, immediately thereafter, the identical asset can be repurchased, with a new tax basis established in the amount of the purchase price.

Accordingly, installment payments received after 2012 are subject to the tax rates for the year of the payment, not the year of the sale. Thus, the capital gains portion of payments made in 2013 and later may be taxed at the 20 percent rate.

Five-Year Holding Period for Capital Assets

There is no special capital gain treatment in 2011 or 2012 for property held for more than five years. After 2012, the JGTRRA-based lower capital gain rates for five-year gain of individuals, estates and trusts are scheduled to be revived. Long-term gain on the sale or exchange of property held for more than five years generally will be taxed at 18 percent (eight percent for taxpayers in the 15 percent bracket).

Impact – For higher-income taxpayers, the 15 percent rate applies if the taxpayer has held the asset for more than one year, but only if the taxpayer sells the asset by no later than December 31, 2012. The 18 percent rate for qualified five-year property applies if the taxpayer acquired the asset in 2001 or later, has held the asset for more than five years, and sells it after December 31, 2012. The 20 percent rate applies if the taxpayer acquired the asset in 2001 or later, sells the asset after December 31, 2012 and has held the asset for more than one but not more than five years; or has held the asset for more than five years but acquired the asset by exercising an option, right or obligation to acquire the property and the taxpayer has held such since before 2001.

Dividends

The 2010 Tax Relief Act extended the reduced net capital gains tax rates for qualified dividends through 2012. These rates had originally been enacted by JGTRRA. The maximum tax rate for qualified dividends received by an individual is 15 percent for tax years beginning before January 1, 2013. A zero percent rate applies to qualified dividends received by an individual in the 10 or 15 percent income tax rate brackets.

Impact – Absent extension, qualified dividends will be taxed at the applicable ordinary income tax rates after 2012 (with the highest rate scheduled to be 39.6 percent). Qualified corporations may want to explore declaring a special dividend to shareholders before January 1, 2013. President Obama’s proposed fiscal year (FY) 2013 federal budget recommended increasing the dividends rate to the ordinary income tax rate for higher-income individuals.

Other Dividend-Related Provisions

The following business-entity related tax breaks associated with dividends are also scheduled to sunset after 2012:

Dividends received from a regulated investment company (RIC), real estate investment trust (REIT) and other qualified pass-through entities are treated as qualified dividends for purposes of the reduced tax rates through 2012;
Temporary repeal of the collapsible corporation rule will end after 2012;
The accumulated earnings tax rate imposed on corporations which had been reduced to 15 percent will rise to 39.6 percent after 2012; and
The tax on undistributed personal holding company (PHC) income will also rise from its temporary 15 percent rate to the highest individual tax rate.

Uncertainty is always a factor in tax planning. In 2012, uncertainty is magnified by the unknown fate of countless tax provisions on which taxpayers have relied in recent years. The uncertainty is expected to continue until after 2012 elections; and maybe even into 2013. Our office can help you plan for all of this uncertainty, by adopting strategies that allow you to remain flexible for as long as possible while being prepared to act on opportunities before they are lost to time and changing laws. Making plans now to accelerate certain income, defer specific deductions, and realize capital gains are only some of the strategies that might fit your situation.

 

 

 

Reproduced with permission from CCH’s Client Letter, published and copyrighted by CCH Incorporated, 2700 Lake Cook Road, Riverwoods, IL 60015.

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