Year End Tax Planning in an Election Year
Year End Tax Planning in an Election Year
Regardless of which of the candidates is successful in becoming our 44th President, a significant change in tax policy is likely to occur, beginning in 2009. How dramatic a change will depend on several factors; not only which Presidential candidate is elected, but which party controls the House of Representatives and Senate, the size of that majority, and the state of our economy.
Significant tax legislation in 2009 may not occur until the last half of the year. However, there is precedent for a tax law change enacted mid-year being made retroactive to the beginning of the year. This happened in 1993 with the Clinton tax increase. So what can be done in 2008 to anticipate, and minimize the impact of, the likely changes in tax laws resulting from a change in administration? The following tax planning strategies are worthy of consideration.
Change in Long-Term Capital Gains Tax Rate
Many individuals have enjoyed a relatively low tax rate, from 5% to 15%, on gains recognized from selling most types of property held more than 12 months. Some gains on depreciable real estate have been subject to a 25% tax rate. These tax rates have been the target of those in Congress who view it as a tax benefit for the rich, and an increase in the long-term capital gains tax to rates to a 20% or 28% tax rate, rates that existed during President Clinton’s term, has been suggested.
Individuals with significant long-term capital gains on publicly traded securities should consider the tax benefit of selling these positions before year-end to assure a federal tax rate of 15% or less. After the beginning of the year, an additional 8% to 13% of those gains could be paid to the U.S. government.
Individuals selling closely-held business interests will also be impacted by increased long-term capital gains taxes. If a sale can be completed by year-end, it would be worth considering collecting all of the sales proceeds before the end of 2008, rather than carrying any of the sales proceeds on an installment contract. Even though the business is sold in 2008, the gain attributable to any proceeds collected after the end of 2008 may be subject to the capital gains tax rate in existence in the year proceeds are collected. Alternatively, in the year of sale, a taxpayer can elect not to report the gain on the installment method, and subject the entire gain to tax in the year of sale. Just make sure enough sales proceeds are received in 2008 to pay the tax on the entire gain.
Real estate investors considering a Section 1031 like-kind exchange to defer tax on any gain realized on property exchanged should consider whether it would be more beneficial, taking into consideration the likely number of years replacement property will be held before income tax would be paid, to forego a like-kind exchange and sell the property before the end of 2008 to subject the gain to a lower capital gains tax rate.
Beginning in 2003, the federal tax rate on qualifying dividend income dropped from the ordinary income tax rate (a maximum 35%) to the tax rate on long-term capital gains (5% to 15%), resulting in a reduction in rate of as much as 20% of the amount of qualifying dividends. Reducing the actual tax on dividends by 50% or more is also viewed by those in Congressional leadership as being a tax benefit for wealthy individuals, and could be targeted to revert to ordinary income tax rates beginning in 2009.
Corporations with earnings & profits should consider the advisability of paying dividends to shareholders in 2008 while the lower tax rate on qualifying dividends still exists. S corporations with C corporation earnings & profits may also want to consider the advisability of paying taxable dividends (this requires an election be filed with the 2008 tax return) particularly if, by doing so, it can eliminate its C corporation earnings & profits. However, in general, if a C corporation is not likely to be required to pay dividends in the near future to avoid accumulated earnings tax, not paying dividends will result in less overall tax.
Senator Obama has indicated that he will push for an increase in social security taxes for those individuals earning more than $250,000 a year. If such a proposal is enacted, partners in a partnership, or members in an LLC taxed as a partnership, will pay self-employment tax on significantly more of the earnings of the partnership regardless of how much is distributed by the partnership to its partners. An alternative would be for the partnership / LLC to incorporate and elect to be taxed as an S corporation. The S corporation would pay reasonable salaries to its shareholder-employees, subject to social security tax, but would also distribute tax-free dividends to its shareholders that would not be subject to social security / self-employment taxes.
There has been much discussion in recent years of doing away with the federal estate tax, to the point where many individuals have presumed there is no need for estate planning to save federal and state estate taxes. However, it now seems likely that the federal estate tax will continue, and that the recent increases in estate tax-exempt accumulation of wealth ($2 million per individual in 2008, $3.5 million per individual in 2009, no federal estate tax in 2010) will revert in 2011, if not sooner, to an estate tax-exempt level of $1 million per individual.
It is therefore critical that business owners and other individuals who have accumulated wealth in excess of $1 million, or $2 million for a married couple, revisit their estate plan to make sure it has been updated for a likely recurrence of the federal estate tax at levels we haven’t seen since 2001, so that more can be passed to your heirs and less to the federal government.
Don’t’ forget that many states and local taxing authorities have expanded their tax base to help offset growing budget deficits, and states are becoming much more aggressive in pursuing out-of-state businesses that are liable for taxes beyond their state of domicile. A review of these taxes by state and local tax specialists may reap significant tax savings, or protect you from significant penalties and interest. .
Regardless of who is elected President in 2008, the Democratic majority in Congress seem intent on changing the tax policy of our country to increase taxes on what it considers to be wealthy taxpayers. It’s important to anticipate the changes that will likely occur and complete certain transactions before year-end to implement a tax-savings strategy.
Because our nation’s federal and state tax laws are extremely complex, you should always consult with your tax advisor before implementing any tax planning strategies.
For more information, please contact your tax advisor.
