Starting in January 2013, the Bush cuts are set to expire, as are other tax provisions that have kept taxes lower than they otherwise would have been. Additionally, other new tax provisions are set to go into effect at the same time that will further increase taxes.
Unless otherwise changed by Congress between now and then, the changes will include:
- The top tax bracket rising from 35% to 39.6%, and at least a 3% bump in tax rates for most individual rate bands;
- The tax rate on long-term capital gains rising from 15% to 20%;
- Qualified dividends will see their top tax rate jump from 15% to 39.6%;
- A new investment income surtax of 3.8% for married-filing-joints making more than $250,000 on all net investment income ($200,000 for single filers). Net investment income subject to the tax includes: interest, dividends and net capital gains, but excludes municipal bond income;
- Expiration of the payroll-tax cut holiday, which will increase the portion of the social security tax on the first $110,000 of payroll income by 2%;
- Expiration of the Alternative Minimum Tax (AMT) patch;
- Increases to the AGI limits on medical expense deductions up to $10,000;
- The return of phase-in limits for itemized deductions for high-income earners.
It is quite possible that some of the expiring provisions will be extended for at least some tax payers. The Senate Democrats have proposed extending many of the Bush tax cuts for those making under $1MM, while President Obama has proposed extending for those making less than $250,000. It is quite likely we won't know the outcome until at least election time - and regardless of who wins, we may not know the entire tax picture until after the beginning of 2013 as it is possible the tax cuts could be extended retroactively sometime in 2013.
There are also scheduled changes and expirations which may affect estate planning, and once the picture becomes clearer, it may make sense to revisit your estate planning.
Here are a few strategies to consider, although I would be reluctant to implement any of these until late this year so as not to incur unnecessary tax and trade costs until there is no choice (just in case the Bush tax cuts are extended).
- Consider taking capital gains in 2012 instead of deferring into 2013. This would mean recognizing many of the gains in any taxable account this year instead of deferring them into the future as we have generally tried to do. The goal here would be to pay the taxes sooner, but at a hopefully lower rate.
- Conversely, consider holding off on recognizing losses this year to save them for 2013 and beyond when the net tax savings from those losses may be greater.
- Other sources of income over which you may have some control could be accelerated into the present year as well to take advantage of the potentially lower rates now in place.
- Conversely, any deductible expenses could be pushed into next year, as those deductions may be more valuable then than now.
- Additionally, it may make sense to consider moving a greater percentage of any fixed income holdings into comparable maturity/quality municipal bonds. These may look relatively even more attractive with higher federal tax rates and the fact that muni income would not be subject to the new 3.8% surtax on investment income.
- Finally, consider a Roth conversion on existing IRA assets, but only to the degree that you could keep your income in a lower bracket this year than you will likely be in in the future, new tax rates included. It would only make sense to convert to a Roth now if you think your tax rate in retirement (or potentially for your heirs) will be higher than it is now.
Please let me know if you would like to discuss year-end tax planning, although it may make sense to hold off until we are closer to the end of the year as the picture may be become a bit clearer . . . and as always, please let us know if there is anything we can do for you.