United States: Taxmageddon - 1/1/2013: Pending Increases In Income Tax Rates

Last Updated: July 30 2012
Article by Stephen C. Curley and Raj Tanden

As we approach the fall election, one of the most discussed topics is Taxmageddon: the pending, significant increases in individual income tax rates despite a weak — and apparently weakening — economy. If Congress fails to act, and there is no expectation that it will do so prior to the election, U.S. federal income tax rates will automatically increase on January 1, 2013. While the Administration seeks an extension of the "Bush Tax Cuts" for those earning less than $250,000 and Republicans press for an extension for all taxpayers, it is possible and perhaps probable in the current political climate that there will be no extension for any taxpayers. Indeed, some Democrats have advocated for this outcome unless Republicans agree for the more modest extension of the tax cuts, especially in view of the widening budget deficit. There is also the possibility that there will be no tax act in 2012 and then a retroactive tax decrease for some taxpayers next year.

Linked here is a detailed presentation on the expected increase in tax rates.1 In summary, the maximum federal long-term capital gain rate will increase from 15% to 23.8%, including a new 3.8% "healthcare tax" on interest, dividends, capital gains, and other passive income realized by "high earners." The Supreme Court recently upheld the tax as part of its decision on the healthcare act and the tax would apply to individuals earning more than $200,000 per year ($250,000 in aggregate for married taxpayers). The maximum tax rate on passive, ordinary income, such as interest and dividends, would increase from 35% to 43.4%, including the healthcare tax. The new 3.8% tax also would apply to wages of these earners, increasing the current "Medicare" tax borne by individuals from 2.9% to 3.8%. In this connection, the "employee portion" of the tax would increase from 1.45% to 2.35%. The "employer portion" would remain the same at 1.45%.

Some states are also considering tax increases. For example, in the fall election, California voters will be asked to increase the maximum individual California income tax rate on all sources of income, including capital gains, from 10.3% to 12.3%. This increase would take effect on January 1, 2013 as well and the highest rate would apply to an individual's California taxable income in excess of $500,000. Assuming this referendum passes, which has been aggressively supported by California Governor Jerry Brown, a California resident's total capital gains tax rate could increase to as much as 36.1% (23.8% federal and 12.3% state) — over a 60% increase over the current rate (15% federal and 10.3% state)!

The impact of these increased tax rates could be substantial on the after-tax proceeds realized by the holder of appreciated property, such as equity in a business, intellectual property (e.g., a patent), or real property.

For example, assume that a founder of a business resident in California expects to realize $50 million from the sale of her business and that she has a $10 million tax basis in her stock. If she sold the business in 2012, she would pay approximately $10.1 million in taxes (($50 million – $10 million) x 25.3% aggregate tax rate), netting approximately $39.9 million in after-tax proceeds from the sale. By contrast, if she sold in 2013, she would pay approximately $14.4 million in taxes (($50 million - $10 million) x 36.1%), netting approximately $35.6 million in after-tax proceeds from the sale. Thus, after tax proceeds would be reduced by over 10% — and this example is "real world."

A typical sale transaction can take months to complete from the time the decision to sell is made. Accordingly, the owner of a business seeking to sell the business in the near term should take immediate steps to increase the likelihood of completing the sale before year-end. If the owner's business is in demand, he or she may be able to negotiate a "tax indemnity" under which the purchaser would indemnify the owner for the increase in rates if the transaction doesn't close in time. There also are certain tax-acceleration techniques that a seller could use to accelerate taxable gain into 2012 at the lower rates. For example, a seller could sell his or her company for a promissory note for most of the proceeds payable in 2013. The seller could "elect out" of the installment method and recognize all of the gain in 2012. Under appropriate facts, the seller might be able to "rescind" the sale and not recognize any gain from the sale. Similarly, the buyer could escrow the sale proceeds in 2012. If the deal closed in 2013, the proceeds could be distributed to the seller and the seller could potentially (again, under the right facts) recognize the gain in 2012. Alternatively, a seller could use the "constructive sale" provisions of Section 1259 of the Internal Revenue Code to recognize gain this year without actually selling the appreciated property. There are several options available for gain acceleration under Section 1259. Sellers are urged to talk to their tax advisors.

The Bottom Line

If you hold appreciated property, wish to obtain liquidity from the property in the near future, and have not begun to consider monetization transactions, you should do so as soon as possible to take advantage of lower tax rates that will expire at the end of this year under current law. Even if you cannot complete a sale by the end of the year, there are techniques under which you potentially could accelerate taxable gain into 2012 and therefore pay tax under the lower rates even if liquidity doesn't occur until thereafter.

Footnotes

1 This presentation was prepared together with The Sage Group, LLC, an established Los Angeles-based investment bank.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Lowndes, Drosdick, Doster, Kantor & Reed, P.A.
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Lowndes, Drosdick, Doster, Kantor & Reed, P.A.
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions