According to what, if any, tax legislation Congress can enact over the following several weeks, we are going to likely notice a tax increase for 2013 and then years. Having said that, the following are some key strategies that should be considered.
Business Expense Strategies
If you are a cash-basis taxpayer and business proprietor operating being an S corporation, partnership or sole-proprietorship, you pay tax about the businessís net income on your individual federal taxes return. The business itself doesn't spend the money for tax. Therefore, an increase in tax rates will affect you. Now is the time to plan of these tax rate hikes. Specifically, seriously consider whenever you incur deductible business expenses. You might postpone many of these expenses with a future year when tax rates might be higher. On the other hand, businesses with carry-forward losses will benefit more by accelerating income (to the extent possible according to tax law) into 2012 and deferring expenses to 2013 or later.
Local and state Tax Payment Strategies
Taxpayers usually have some flexibility in determining when you make local and state tax payments. Such payments include income tax, real estate and property taxes. All of these items could be deductible to suit your needs based on your tax situation. Research your situation to ascertain whether you've got flexibility to delay these payments into next season. The delayed payment, and subsequent boost in tax deductions, may provide greater tax savings the coming year if tax rates increase.
Timing Charitable Contributions Strategies
When you consider additional 2012 charitable contributions, you should project to 2013. It might be advantageous to separate your charitable giving budget involving the 2 yrs. A charitable deduction (so long as it is not at the mercy of limitation according to your income) could potentially be more useful for 2013 than in 2012. After a little analysis, you may find it more beneficial to reduce your remaining 2012 charitable contributions and allocate more assets (cash or securities) in your 2013 charitable budget. If you determine to watch for 2013 to make charitable gifts, you should consider which makes them with appreciated long-term assets rather than cash. Due to the possibility of rising tax rates, this strategy needs a second look. When the technique is appropriate, the benefits are twofold:
When gifting appreciated stock to charity you avoid incurring capital gains taxes around the stock
A present to some qualified charity offers a tax break, towards the extent it isn't limited based on your income.
Be sure to discuss this choice to insure expenditures are fully deductible.
With respect to payments out of your employer, consider whether you expect finding a bonus or perhaps a lump sum payment due to retirement or even a job transition, and talk with your employer about your flexibility inside the timing of getting the payment. Some workers are offered transition payment schedules that stretch over more than one year. This may not be ideal when tax rates are required to increase as with 2013. An assessment of the payment amount, date(s) of receipt and your expected taxes bracket in 2012 and future years will be important in deciding or negotiating when you should receive this income.
With respect to IRA or annuity distributions, taxable distributions from IRAs or annuities certainly are a concern inside a rising-tax-rate environment. If you're necessary to take minimum distributions from the retirement plan, IRA or inherited IRA, youíll want to ingredient that into future-tax-year projections. Taking mandatory distributions boosts your taxable income and may even require either a rise in your withholding or, perhaps, paying estimated taxes quarterly to avoid an underpayment penalty. If youíre considering taking an elective distribution over the following several years, by taking your distribution this year when income-tax-rates are lower is a great idea. This tactic is especially timely when it comes to potential distributions and recognition of taxable income as a result of a Roth IRA conversion.
IRA to a Roth IRA Conversion Strategies
Anyone, regardless of income, now can convert a regular IRA to some Roth IRA. The benefits of converting would be the potential for tax-free income in retirement and the ability to spread assets your heirs can withdraw tax-free after your death. However, you could incur income tax around you are making the conversion. Because rates are scheduled to increase on January 1, 2013, if youíre considering converting, you might be best doing the work this season instead of in 2013.
Accelerating Long-Term Capital Gains Strategies
January 1, 2013, could see the end of historically low long-term capital gains rates. How much these rates will increase depends on your ordinary taxes rate bracket. Various Congressional proposals have been made that included alternative schedules, by incorporating affecting only higher-bracket taxpayers; however, at this point they continue to be just that - proposals. Since it stands now, some think it's good for sell appreciated securities or assets that youíve held for a long time next year to take benefit of this yearís lower capital gains tax rates. This tactic may be particularly appropriate in certain situations: You can make use of the current 0% long-term capital gains rate. If the net taxable income, including your long-term capital gains, is less than $70,700 (joint filers) or $35,350 (single filers) next year, you'll be inside the 10% or 15% ordinary tax bracket, therefore you might be able to realize some tax-free long-term capital gains. If your capital gains push you over your threshold, or you will be in a higher income tax bracket, then some or every one of the gains will probably be taxed in the 15% long-term capital gains rate.
If you hold a concentrated equity position, meaning an amazing position in a single stock which includes appreciated over time, selling a percentage with the shares and getting other investments with all the proceeds can help you diversify and lower industry risk in your portfolio. For those who have other goals which entail recognizing the gain, then you need to assess the various ways of help manage the chance of a concentrated position and the tax liability that could occur upon selling a purchase. However, due to the limited strategic window for 2012ís historically low long-term capital gains tax rates, you might want to seriously consider selling some this coming year. This will help you steer clear of the potential tax rate increase that's scheduled for long-term capital gains recognized in 2013 and thereafter.
If you own real estate or business assets, the upcoming tax rate changes should prompt one to consider how you are managing those assets. In some cases, the customer and seller for these assets can structure the sale so that proceeds are paid over more than one tax year. Typically, this tactic helps the vendor manage their tax liability. However, given that both ordinary income tax rates and long-term capital gains tax rates are scheduled to rise in 2013, you might like to try to complete a sale, and receive its proceeds, next year. If that's not possible, remodel which will electing away from an installment sale treatment and accelerating the wages recognition all to 2012 might be an option.
Think ahead before selling if you opt to sell appreciated securities this year to take good thing about the reduced long-term capital gains rates, but be strategic in how you do it. For your part of your portfolio you have designated for long-term goals, review and rebalance your allocation so that you are in a better investment management position moving forward. Doing same goes with enable you to benefit from 2012ís lower long-term capital gains tax rates, plus long term you might need less rebalancing, which will lessen increases in size that you realize if the tax rates are higher.
Accelerating Capital Losses Strategies
Typically, investors consider selling investments near year-end to appreciate losses to offset capital gains or up to $3,000 in ordinary income. However, when you have modest unrealized losses in 2012, , nor anticipate generating sizable capital gains, you might consider waiting to understand those losses until 2013.
Offsetting long-term capital gains which are taxed at 20% (the 2013 rate) will give you more tax savings than while using losses to offset gains taxed at 15% (the 2012 rate). Youíll will want to look closely to project any potential capital gains (and donít forget about long-term capital gains distributions from mutual funds). For investors whose income (including long-term capital gains) is inside the 10% or 15% tax bracket, harvesting losses is not going to provide a tax benefit whether it only reduces long-term capital gains. Losses in excess of gains will offer a nominal tax savings at best and may even provide more quality if left for future years.
If, on the other hand, you've got substantial capital losses or capital loss carry-forwards, it may sometimes be hard to consume those losses. In this case, it likely doesn't make sense to postpone offsetting capital gains or waiting to recognize gains.
Rebalancing Your Portfolio Strategies
Generally speaking, a professional dividend is one paid by a U.S. corporation or an international corporation that trades on the U.S. stock trading game. You may even be given a qualified dividend in the event you hold shares in the mutual fund that invests in these types of corporations.
Currently, qualified dividends are taxed at a maximum 15% rate - like long-term capital gains; however, in 2013, they may be scheduled to be taxed at ordinary income tax rates, which could be described as a maximum 39.6% rate (and quite possibly an additional 3.8% Obamacare surtax on huge salary taxpayers). Given this anticipated change, you might want to consider reallocating the portion your portfolio locked in taxable accounts using the following strategies.
Attempt to add growth-stock holdings. If you donít need current income, you might like to think about the features of shifting some of your equity allocation to growth stocks. Or you might reposition some of your tax-deferred account allocation to dividend-paying stocks, in which the dividends is going to be shielded from current taxation. Having a dividend-paying stock, your total return is dependant on both growth and income, and the income portion could be taxed as everyday income starting in 2013.
Should you hold an improvement stock for a long time, any appreciation within the stockís price will never be taxed before you sell it off. When this occurs, you would owe long-term capital gains taxes (as long as you held the stock more than one year), which will be less than ordinary income rates despite 2012. Because this plan involves issues surrounding both your long-term asset allocation and taxation, cautious should be implemented to help determine the right strategy for your circumstances.
Reassess your tax-exempt bond holdings. If you'd like income, carefully weigh the pros and cons of tax-exempt bonds versus dividend-paying stocks. With rising tax rates, tax-exempt income could be more inviting. Dividend-paying stocks risk having their dividend reduced or eliminated altogether. Also, tax-exempt bonds are often less volatile than stocks.
However, tax-exempt investments have inherent risks. For instance, bond investments is probably not too equipped to safeguard against inflation as stocks. In addition, take into account that some municipal bond interest may trigger the AMT tax. Also, bond prices will fluctuate and move inversely to interest rates. If rates of interest increase, your bond investmentsí principal value will fall. We recommend continual portfolio monitoring and also the outlook for the economy and also the markets, so any proactive changes can be made at the appropriate interval.
Youíll want to measure the investmentís yield. At 2012 income-tax-rates, a tax-exempt bond with a 4% yield could be much like a taxable investment with a 5.3% yield for somebody within the 25% federal tax bracket. If income tax rates increase, this same taxpayer will have to locate a taxable investment using a 5.6% yield to create exactly the same after-tax income since the 4% tax-exempt bond.
If you decide to alter your portfolioís investment mix, remember that overall asset allocation remains appropriate for your investment goals, time horizon and risk tolerance.
Medicare Tax on Investment Income Strategies
Beginning in 2013, married filing joint taxpayers with incomes over $250,000 and single taxpayers with incomes over $200,000 will be susceptible to a brand new (Obamacare) Medicare tax. If youíre in either group, one more 3.8% tax will be put on some or your entire investment income, including capital gains. This is in addition to ordinary and capital gains taxes which you already pay!
Exercise Employer-Granted Stock Options
If the company grants you commodity as part of your compensation package, you may have either (or both) nonqualified stock options (NSOs) or incentive investment (ISOs). You will need to comprehend the choices you've and the tax consequences of exercising each type of stock option. NSOs give you the choice to exercise your options sometime involving the vesting date and also the expiration date. (See your stock option plan document or perhaps your employee benefits representative if you don't know these dates.) Once you exercise an NSO, the real difference involving the stockís fair rate as well as the exercise price is going to be taxable compensation thatís reported on your own W-2. For those who have vested options and the chance to exercise them next year or 2013, youíll need to determine in which year it may be more beneficial to exercise your options and recognize the wages. You may want to project your taxable income for 2012 along with a later year after which decide after which it might be less taxing to exercise your choices and realize the excess income. Youíll also want to consider the stockís market outlook, its valuation and the optionsí expiration date, inside your decision-making process.
ISOs are a little bit more complex because your holding period determines if the exercise proceeds are taxed as standard income (just like NSOs) or long-term capital gains. To profit from your potential long-term capital gains tax treatment (using its 15% top rate in 2012 and 20% top rate in 2013) versus ordinary income-tax-rates (which range approximately 35% next year and 39.6% in 2013), you must hold the stock you receive more than one year from the exercise date and most a couple of years from the grant date. Because of the holding period requirement, itís obviously too late to secure the 15% capital gains tax rate on options you have not yet exercised. However, in the event you exercised options in 2011 or earlier but still contain the shares, youíll wish to weigh the advantages and disadvantages of advertising them and recognizing gains in 2012 versus old age.
You should also be aware that in the event you exercise and hold shares out of your ISO exercise, the taxable spread (the difference between the stock price around the exercise date and your option cost) is going to be taxable income for AMT purposes around where the exercise occurs.
In the event you exercise your ISOs and then sell without meeting this holding period, you'll recognize taxable W-2 compensation similar to NSOs. Due to the lower capital gains rates, some think it's more attractive to hold ISO shares rather than selling them soon after your exercise. Just make sure you consider any ATM tax potential.
If, instead, you choose to exercise ISOs and then sell the stock, you might want to consider selling by year-end to take advantage of 2012ís lower ordinary income tax rates. Just like NSOs, youíll want to industry outlook for that stock, within your decision-making process.
Anthony Caruso, CPA has practiced being a certified public accountant and investment advisor for more than Thirty years. Caruso and Company, P.A. can be a Registered Investment Advisor offering paid management of their money, tax and financial planning. Information contained above is not supposed to have been a suggestion to buy or sell any specific investments, or take specific tax actions and individuals should consult with their advisors for appropriate advice concerning their individual circumstances.