With the elections now behind
us, we have a little more clarity regarding what lies ahead from an economic policy
perspective. Some initiatives, such as
Proposition 30 (Temporary Taxes to Fund Education) are certain to raise taxes
for California residents immediately. In
fact, the terms of Proposition 30 go into effect retroactively to January 1, 2012.
Prop 30’s provisions include creating a series of high income tax
bracket rate increases (see the table below) beginning at $250,000 taxable income for single taxpayers and $500,000 for joint taxpayers. Also the sales tax rate for California will
increase from 7.25% to 7.5%. Estimated
revenues expected to be generated from Prop 30 range from approximately $7
billion to $9 billion with most of the funds allocated to K-12 grade levels
with the balance going to community colleges.
Other issues affecting how
much we pay in taxes, often referred to as the “Fiscal Cliff”, are not quite as
clear in terms of the final outcome at this point. The “Fiscal Cliff” reference includes tax
increases that will go into effect January 1, 2013 such as the reversal of last
year’s payroll tax cuts, expiration of income tax rate cuts put into
effect by President Bush and his team in
the early 2000’s, the start of taxes related to President Obama’s healthcare
law, cuts in defense and non-defense spending (approximately equally), etc.
President Obama has been
clear that he wants to let the Bush tax cuts expire on December 31, 2012 for
those earning over $250,000 annually.
Although it is possible President Obama and the Democrat controlled
Senate may compromise and extend those tax breaks for a year or so, there’s still
a strong chance those cuts will be allowed to expire and higher Federal income
tax rates will accompany higher State income tax rates for many California
business owners.
TAX PLANNING CONSIDERATIONS
Generally the rule of thumb
is to defer income and accelerate deductions as permissible using a variety of
strategies. With the prospect of income
tax rates rising January 1, 2013, it may be wise to abandon the general rule
and bring income, at least in a measured way, into 2012. With federal tax rates set to increase as
much as approximately 5 points (from 35% Federal to 39.6%), it seems quite
appealing to take income now rather than paying almost 5 points higher in
federal taxes next year. In this
environment, it is difficult to get much return on investment so why not
consider taking the several point benefit in 2012? Of course President Obama and Congress may
extend the Bush-era tax cuts for all, including the high income earners, but in
my view playing roulette with those prospects isn’t worth earning only a
deferral (remember, it’s only timing we’re talking about). If you gamble and win, you pay taxes next
year (a nice benefit and supplement to cash flow to be sure) instead of this
year at the same rates as 2012. If you
gamble on this issue and lose, you pay taxes next year anyway, just at higher
federal rates.
Another issue that has to
come back into the conversation is whether S Corporation status is as attractive as it’s been these past many years for
small business owners. See my article on S Corporations wherein I discuss this issue in January 2009 in my final
paragraph of that posting. The average
corporate federal tax rate is 34% (there are lower tax rates for corporations
with taxable income less than $75,000 which get phased out at higher income
levels). The California State Corporate
tax rate is 8.84% and the personal tax rates (see schedule below) will fall
somewhere between 10.3% and 13.3% for many business owners who are structured
as S Corporations. Given the higher
personal income tax rates versus corporate tax rates, it makes sense to consult
with your advisors as to whether S Corporation status still makes sense. In many cases the answer will still be yes as
avoiding the double taxation of corporations, especially in a liquidation
event, will still win the day for S Corporations.
California Personal Income Tax Rate Structure Under Prop 30
Single Filer's Taxable
Income
|
Joint Filer's Taxable
Income
|
HOH Taxable Income
|
Current Tax Rate
|
Additional Tax Rate
|
Total Tax Rate
|
250,000-300,000
|
500,000 - 600,000
|
340,000-408,000
|
9.3%
|
1.0%
|
10.3%
|
300,000-500,000
|
600,000-1,000,000
|
408,000-680,000
|
9.3%
|
2.0%
|
11.3%
|
Over 500,000
|
Over 1,000,000
|
Over 680,000
|
9.3%
|
3.0%
|
12.3%
|
