The “Gordian knot” today is what should a businessman or an investor do in light of the expiration of the Bush income tax cuts and the imposition of new taxes effective in 2013.

Income taxes and the tax rates have at least three important consequences to taxpayers.  First, it affects entity selection: whether the taxpaying entity is an individual; a flow-through organization such as a partnership or Subchapter S corporation; or is a C corporation. Second, the determination of whether to sell today or defer until a later point is impacted by the tax rate. Lastly, the taxation choice of income mix to the recipient, whether in the form of wages, dividends, and capital gains, is of increased tax significance.

The 2001 Bush tax cuts will sunset and expire as of December 31, 2012.[1] How the expiration of these tax cuts will affect tax rates is set forth below:



Please click here to view table.


Please click here to view table.


Please click here to view table.


Please click here to view table.


Please click here to view table.

In addition to the “inlaw” tax increases scheduled for 2013, new taxes were passed in the Health Care Bill in 2012, effective 2013.

Individuals will pay an extra 0.9% Medicare tax on earned income in 2013. That is, an individual’s tax rate will increase from 1.45% to 2.35% for single taxpayers with earned income of $200,000 and for married filing jointly with earned income of $250,000. This increase only affects the employee’s portion and not the employer’s. It will appear as a separate line on Form 1040.

Starting in 2013, individuals will also be required to pay a new Medicare surtax on unearned income of 3.8% on modified adjusted gross income for couples earning more than $250,000 and $200,000 for singles. The new 3.8% unearned income surtax will be imposed on interest, dividends, annuities, rents, royalties, passive income, capital gains, and financial instrument trading. It will not include tax-exempt interest, self-employed income, active business income, IRA, or retirement distributions. 

Therefore, in 2013, a capital gain could be taxed at 23.8% (20% capital gain tax plus 3.8% Medicare surtax). 

Moreover, in 2013, dividends could be taxed at 43.4% (39.6% ordinary income tax plus 3.8% Medicare surtax).

It is also important to remember that dividends, which are payouts from business earnings, are already taxed at the corporate rate of 35%. The individual dividend tax is a second levy on that same income that is already taxed to the corporation, and a rate of 43.4% to the shareholder would increase the total tax to $0.60 on each dollar paid in dividends. These are not unsubstantial tax adjustments.

Further, the individual medical expense deduction threshold will increase from 7.5% to 10% of adjusted gross income through the recent health care tax changes.

If taxes are a concern, an individual who can sell their business in 2012 may want to consider doing so. An illustration will make the point.

The long-term capital gains rate has ranged from 15% to 28% since 1981; and, as indicated above, the current rate is 15%. Below is a table that represents the percentage increase in the sale price of an asset needed to achieve the same net after-tax proceeds using various capital gains tax rates.


Please click here to view table.

The new tax environment contains many provisions that will affect you and your business, such as choice of entity, the determination to sell now or defer, and how to arrange your income mix to get the best tax position without sacrificing security and safety (wages, dividends, or capital gains).

While the expiring Bush tax cuts are under Congressional review and some of the health care tax provisions do not take effect until 2013, businesses and individuals need to assess their tax situation and plan ahead how to best survive in an increasing tax environment.