Cliff Diving Is Not for the Faint of Heart– November 12, 2012 by Mike Kolk

In cliff diving the difference between a masterful performance and crippling calamity is razor thin. Now that the presidency and the composition of Congress for the next two years have been determined, our elected fiscal cliff divers must navigate a similarly thin line between success and failure.

So how should you go about tax planning given the slim difference between landing with a splash or a crash? By being informed, prepared and flexible. Clearly, as is true every year, tax planning is personal to your unique situation and sometimes may be best served by acting contrary to general guidelines. This is the reason it always makes sense to touch base with your tax planner before the year ends.

This year the general guidelines are especially fuzzy. We have a lame duck Congress that may or may not try to act before terms expire. We also have the expiring Bush tax cuts that will increase taxes at all levels at year end. Absent a change, higher earners will feel the pinch of higher tax rates; middle and lower earners may have to pay taxes for the first time in a while or be sideswiped by a significant alternative minimum tax hit that has been patched over for some time.

Layer on top of this the distasteful political posturing and gimmickry of both parties. Waiting until tax rates rise by statute in 2013 and from there reducing them retroactively is not a tax cut if the result is higher rates than 2012. It’s no different than increasing 2013 tax rates now. However politicians don’t always see it that way. There is also the growing specter of a complete rewrite of the tax code. In my opinion we are due for one — recent rewrites were in 1939, 1954 and 1986. If that happens, all bets are off and many sacred cows may end up as lunch.
So what are the general guidelines this year? The status quo offers a reasonable baseline to compare against in this sense. It is safe to conclude that 2013 taxes will not be going down from today’s levels, so this will not be a year in which finding ways to defer income that might otherwise be taxed or to accelerate most deductions that might otherwise be deferred would be typical.

Additionally, the time value of money continues to be at historical lows. Accordingly, the economic benefit of deferring tax costs into the next year is less powerful than in prior years. This means that the opportunity cost of accelerating net taxable income into 2012 is far lower in the event we end up with some kind last minute “Mega Patch” that merely extends most of the current tax laws into 2013. A patch would simply buy time to address the bigger issues. Based on recent congressional trends, this alternative may be likely. Unfortunately there seems to be a required game of political chicken that first must occur. Time is not our friend here, but the downside seems to be limited.

So the bottom line is talk to your tax team, map out alternatives and be ready to act if we are fortunate enough to buck recent history and have certainty about taxes sooner. Some plans will be lucky enough to have hindsight built into the strategy (for example, Roth IRA conversions and installment sales of capital assets other than publicly traded stock). Many plans require more custom tailoring, but generally, pulling income into 2012 and deferring deductions into 2013 will provide increased chance for savings and less risk of missed opportunity. As always, be careful if this shift distorts rates in either year.

Ironically, cliff diving began in the 1700s in Hawaii as a way for citizens to show loyalty to the leader. Now we have a Hawaiian born leader who, with Congress, is facing one of the most dangerous cliffs in the country.

Contact Mike Kolk at 330.255.4315 or mkolk@cohencpa.com for more information.

 

This communication is for information only, and any action should only be taken after a detailed review of the specific situation and appropriate consultation.

Notwithstanding that these materials do not constitute legal, accounting or other professional advice, as may be required by United States Treasury Regulations and IRS Circular 230, you should be advised that these materials are not intended or written to be used, and cannot be used by you or any other person, for the purpose of avoiding penalties that may be imposed under federal tax laws. No written statement contained in these materials may be used by any person to support the promotion or marketing of or to recommend any federal tax transaction(s) or matter(s) addressed in these materials, and any taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor with respect to any such federal tax transaction matter.