Planning in 2012 for “Taxmageddon” in 2013

 There were many reasons for giving thanks last week on Thanksgiving Day, but I’m guessing tax increases were not the most popular of reasons to be shared at the table. Unless you have been in a long coma, you should have now heard about the potential tax increases in 2013 of which the media is referring to as “taxmageddon” due to the potential to be the greatest tax increase in our American history. The following gives you an idea of some of the major changes and some planning considerations:

The following changes will occur in 2013, unless we have new tax legislation:

•  Ordinary income tax rates are increasing: The currect six tax brackets ranging from 10% to 35% will disappear and in their place will be five tax brackets ranging from 15% to 39.6%.
•  Long term capital gains are increasing: Long term capital gains will be taxed at 20%, instead of their current 15% maximum rate.
•  Qualified dividends will be taxed at higher rates: All dividends will be considered ordinary income subject to the ordinary income tax rates ranging from  15% to 39.6%.
•  Payroll tax rates increasing: Payroll tax rates will increase from 4.2% on wages up to $110,000 to 6.2% in 2013.
•  Medicare surtax: Investment income will be subject to the Medicare surtax. This Medicare tax on investment income will impact people who have adjusted gross income over $200,000 for unmarried persons or over $250,000 for married couples.  Click here to see my blog on the Medicare Surtax.
• Wage surtax 0.9%:  This tax is new and will apply to wages and self-employment income in excess of $250,000 (married filing jointly) and $200,000 (single tax payers).
• Medical expense threshold for deductibility: This is scheduled to increase from 7.5% to 10%.

These are some planning considerations:

• Realizing long term capital gains: Realizing long term capital gains this year to take advantage of the favorable capital gains tax rates might make sense assuming it is consistent with your financial plan such as:
  • Reducing a concentrated stock position if it consists of more than 10% of your investment portfolio
  • Meeting cash flow needs
  • Building needed cash reserves

• Roth IRA Conversions:  Converting pre-tax retirement accounts to a ROTH IRA can be a good strategy given that rates are scheduled to increase and you have a window to re-characterize after the conversion.
• Maximizing your tax bracket:  By estimating your marginal tax rrate you then can plan for any remaining room left in the bracket and recognize additional ordinary income up to the full amount in that bracket without moving into the next bracket.
• Recognize Compensation in 2012:  Recognizing compensation this year will be more beneficial than next year due to the rising rates.
• Establish a non-qualified deferred compensation (NQDC) plan in 2013: For high income earners deferring compensation will help to alleviate the higher tax rates and may help in avoiding the Medicare surtax.
• Consider Re-Balancing Your Portfolio By Tax Type:  Investments that produce orinary income are good candidates for placing into an IRA, 401(k), 529 plan or other tax-deferred savings plan.  Investments that produce long-term gains may produce more optimal tax results in taxable accounts.
• Defer expenses and deductions to 2013 (except for medical expenses):  This will help to reduce taxable income.
• Incur and deduct medical expenses (including insurance premiums) in 2012: rather than in 2013 if you are already above, or if such additional deduction will pu you over, the 7.5% threshold.  

It is very important to work with your financial and tax professional regarding your particular situation to see what might make the most sense for you and your overall financial plan.  Do not hesitate to contact me with any questions or concerns.

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The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.  Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.  Any opinions are those of Center for Financial Planning, Inc., and not necessarily of RJFS or Raymond James.  Unless certain criteria are met, ROTH IRA owners must b 59 ½ or older and have held the IRA for five years before tax-free withdrawals are permitted.  Additionally, each converted amount may be subject to its own five-year holding period.  Converting a traditional IRA into a ROTH IRA has tax implications.  An investor should carefully consider the source of funds used to pay the taxes owned on a ROTH conversion.  Penalties and taxes may apply if the investor uses money from the IRA as a source for conversion taxes.  Consult a tax professional  for details.