Based on what, if any, tax legislation Congress can enact within the next many weeks, we are going to likely experience a tax increase for 2013 and later years. Having said that, listed here are some key strategies that should be considered.
Business Expense Strategies
An advanced cash-basis taxpayer and business owner operating as a possible S corporation, partnership or sole-proprietorship, you pay tax on the business’s net income on your individual federal income tax return. The business enterprise itself doesn't give the tax. Therefore, a rise in tax rates is going to affect you. Now it's time to plan of these tax rate hikes. Specifically, seriously consider whenever you incur deductible business expenses. You could postpone a few of these expenses to some future year when tax rates might be higher. On the other hand, businesses with carry-forward losses will benefit more by accelerating income (towards the extent possible according to tax law) into 2012 and deferring expenses to 2013 or later.
State and Local Tax Payment Strategies
Taxpayers frequently have some flexibility in determining when to make state and local tax payments. Such payments include tax, real-estate and private property taxes. Most of these items might be deductible to suit your needs according to your tax situation. Review your situation to find out whether you've got flexibility to delay these payments into the coming year. The delayed payment, and subsequent increase in tax deductions, may provide greater tax savings next season if tax rates increase.
Timing Charitable Contributions Strategies
While you consider additional 2012 charitable contributions, you should project to 2013. It might be advantageous to split your charitable giving budget between the two years. A charitable deduction (so long as it isn't subject to limitation according to your revenue) might be a little more valuable in 2013 compared to 2012. After some analysis, some think it's more advantageous to reduce your remaining 2012 charitable contributions and allocate more assets (cash or securities) in your 2013 charitable budget. If you choose to watch for 2013 to make charitable gifts, you should think about making them with appreciated long-term assets as opposed to cash. Due to the possibility of rising tax rates, this tactic deserves a second look. If the technique is appropriate, the advantages are twofold:
When gifting appreciated stock to charity you avoid incurring capital gains taxes around the stock
A gift to some qualified charity offers a tax break, to the extent it's not limited depending on your earnings.
Make sure to discuss this method to insure expenditures are fully deductible.
With regards to payments out of your employer, consider whether you anticipate getting a bonus or even a lump sum payment due to retirement or perhaps a job transition, and talk with your employer about your flexibility within the timing of getting the payment. Some personnel are offered transition payment schedules that stretch over multiple year. This isn't always ideal when tax rates are anticipated to increase as with 2013. Overview of the payment amount, date(s) of receipt along with your expected tax bracket this year and long term will become important in deciding or negotiating when you should receive this income.
Regarding IRA or annuity distributions, taxable distributions from IRAs or annuities are a concern in the rising-tax-rate environment. In case you are needed to take minimum distributions from your retirement plan, IRA or inherited IRA, you’ll desire to ingredient that into future-tax-year projections. Taking mandatory distributions boosts your taxable income and may require either a boost in your withholding or, perhaps, paying estimated taxes quarterly to prevent an underpayment penalty. If you’re considering taking an elective distribution over the following several years, by taking your distribution this year when income tax rates are lower may be beneficial. This tactic is particularly timely with regards to potential distributions and recognition of taxable income due to a Roth IRA conversion.
IRA with a Roth IRA Conversion Strategies
Anyone, irrespective of income, now can convert a regular IRA to a Roth IRA. The advantages of converting will be the potential for tax-free income in retirement and also the capacity to spread assets that the heirs can withdraw tax-free after your death. However, you could incur income taxes around you're making the conversion. Because rates are scheduled to boost on January 1, 2013, if you’re considering converting, you may be better off doing it this season as opposed to in 2013.
Accelerating Long-Term Capital Gains Strategies
January 1, 2013, often see get rid 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, with a few affecting only higher-bracket taxpayers; however, at this point they remain exactly that - proposals. As it stands now, it may seem good for sell appreciated securities or assets that you’ve held in the future next year to consider advantage of this year’s lower capital gains tax rates. This strategy may be particularly appropriate in certain situations: It is possible to use the current 0% long-term capital gains rate. In case your net taxable income, including your long-term capital gains, is under $70,700 (joint filers) or $35,350 (single filers) in 2012, you will be inside the 10% or 15% ordinary income tax bracket, therefore you might be able to realize some tax-free long-term capital gains. If the capital gains push you over your threshold, otherwise you are in an increased income tax bracket, then some or all of the gains will be taxed on the 15% long-term capital gains rate.
If you hold a concentrated equity position, meaning a considerable position in a stock which has appreciated with time, selling a portion of the shares and getting other investments with the proceeds can help you diversify minimizing the market risk in your portfolio. For those who have other goals which involve recognizing the gain, then you should evaluate the various ways to help manage the risk of a concentrated position and the tax liability which could occur upon selling the investment. However, given the limited window of opportunity for 2012’s historically low long-term capital gains tax rates, you may want to seriously consider selling some this year. This can help you steer clear of the potential tax rate increase which is 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 you to definitely consider how you are managing those assets. In some cases, the purchaser and seller of these assets can structure the sale so that proceeds are paid over several tax year. Typically, this plan helps the seller 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. You might need not possible, then perhaps electing from an installment sale treatment and accelerating the wages recognition all to 2012 could be an alternative.
Think ahead before selling if you opt to sell appreciated securities next year to adopt advantage of the low long-term capital gains rates, but be strategic in the method that you get it done. For your part of your portfolio you've designated for long-term goals, review and rebalance your allocation so that you will are in a better investment management position moving forward. Doing so will enable you to reap the benefits of 2012’s lower long-term capital gains tax rates, as well as in long term you might need less rebalancing, which should lessen increases in size that you realize when 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, for those who have modest unrealized losses this year, , nor anticipate generating sizable capital gains, you could consider waiting to appreciate those losses until 2013.
Offsetting long-term capital gains that 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). You’ll will want to look closely to project any potential capital gains (and don’t forget about long-term capital gains distributions from mutual funds). For investors whose income (including long-term capital gains) is within the 10% or 15% income tax bracket, harvesting losses is not going to provide a tax benefit if it only reduces long-term capital gains. Losses over gains will offer you a nominal tax savings at best and could provide more appeal if left money for hard times.
If, on the other hand, you've substantial capital losses or capital loss carry-forwards, it could be difficult to consume all of those losses. In this situation, it likely doesn't seem sensible to postpone offsetting capital gains or waiting to identify gains.
Rebalancing Your Portfolio Strategies
Generally speaking, an experienced dividend is a paid by a U.S. corporation or even an international corporation that trades over a U.S. stock exchange. You may even be given a qualified dividend in the event you hold shares in a mutual fund that invests during these kinds of corporations.
Currently, qualified dividends are taxed in 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 may be described as a maximum 39.6% rate (and potentially one more 3.8% Obamacare surtax on high income taxpayers). Given this anticipated change, you might like to consider reallocating the portion your portfolio located in taxable accounts with all the following strategies.
Think about adding growth-stock holdings. In the event you don’t need current income, you might like to consider the advantages of shifting a few of your equity allocation to growth stocks. Or you'll reposition a percentage of your tax-deferred account allocation to dividend-paying stocks, in which the dividends will be shielded from current taxation. With a dividend-paying stock, your overall return is dependant on both growth and income, and also the income portion may be taxed as ordinary income from 2013.
In the event you hold an improvement stock in the future, any appreciation within the stock’s price will not be taxed unless you market it. At that time, you'd owe long-term capital gains taxes (so long as you held the stock several year), that will be lower than ordinary income rates even with 2012. Because this plan involves issues surrounding both your long-term asset allocation and taxation, careful analysis has to be implemented to help determine the proper technique of your circumstances.
Reassess your tax-exempt bond holdings. If you'd like income, carefully weigh the advantages and disadvantages of tax-exempt bonds versus dividend-paying stocks. With rising tax rates, tax-exempt income may be more appealing. Dividend-paying stocks run the risk of having their dividend reduced or eliminated altogether. Also, tax-exempt bonds are usually less volatile than stocks.
However, tax-exempt investments have inherent risks. For example, bond investments might not be as well equipped to safeguard against inflation as stocks. Furthermore, keep in mind that some municipal bond interest may trigger the AMT tax. Also, bond prices will fluctuate and move inversely to interest levels. If interest rates increase, your bond investments’ principal value will fall. We recommend continual portfolio monitoring and also the outlook for your economy and the markets, so any proactive changes can be produced at the appropriate interval.
You’ll want to measure the investment’s yield. At 2012 income tax rates, a tax-exempt bond using a 4% yield could be much like a taxable investment having a 5.3% yield for an individual inside the 25% federal taxes bracket. If income tax rates increase, this same taxpayer will have to locate a taxable investment having a 5.6% yield to build the same after-tax income because the 4% tax-exempt bond.
If you opt to change your portfolio’s investment mix, keep in mind that overall asset allocation remains suitable for neglect the goals, time horizon and risk tolerance.
Medicare Tax on Investment Income Strategies
From 2013, married filing joint taxpayers with incomes over $250,000 and single taxpayers with incomes over $200,000 will be at the mercy of a brand new (Obamacare) Medicare tax. If you’re either in group, yet another 3.8% tax will be applied to some or all your investment income, including capital gains. This will be as well as ordinary and capital gains taxes that you already pay!
Exercise Employer-Granted Stock Options
If your company grants you investment in the compensation package, you could have either (or both) nonqualified commodity (NSOs) or incentive investment (ISOs). You will want to view the choices you've and the tax consequences of exercising each type of stock option. NSOs provide you with the option to exercise your options sometime involving the vesting date as well as the expiration date. (Visit your stock option plan document or maybe your employee benefits representative if you don't know these dates.) When you exercise an NSO, the difference between your stock’s fair market value and also the exercise price will probably be taxable compensation that’s reported in your W-2. When you have vested options and the opportunity to exercise them this year or 2013, you’ll need to determine in which year it may be more advantageous to workout the choices and recognize the wages. You might want to project your taxable income for 2012 and a later year then decide at which time it could be less taxing to workout your options and realize the extra income. You’ll also want to consider the stock’s market outlook, its valuation as well as the options’ expiration date, in your decision-making process.
ISOs are more complex because your holding period determines whether or not the exercise proceeds are taxed as ordinary income (similar to NSOs) or long-term capital gains. To profit from the potential long-term capital gains tax treatment (using its 15% top rate next year and 20% top rate in 2013) versus ordinary income tax rates (which range up to 35% in 2012 and 39.6% in 2013), you need to hold the stock you obtain multiple year from your exercise date and more than two years in the grant date. Because of the holding period requirement, it’s obviously too far gone to secure the 15% capital gains tax rate on options you haven't yet exercised. However, if you exercised options next year or earlier and still contain the shares, you’ll wish to weigh the pros and cons of advertising them and recognizing gains this year versus later years.
You should also remember that in the event you exercise and hold shares out of your ISO exercise, the taxable spread (the difference between your stock price around the exercise date along with your option cost) will probably be taxable income for AMT purposes in the year in which the exercise occurs.
In the event you exercise your ISOs then sell without meeting this holding period, you'll recognize taxable W-2 compensation similar to NSOs. As a result of lower capital gains rates, it may seem more attractive to hold ISO shares as opposed to selling them right after your exercise. Just make sure to consider any ATM tax potential.
If, instead, you decide to exercise ISOs then sell the stock, you may want to consider selling by year-end to consider advantage of 2012’s lower ordinary income-tax-rates. Just like NSOs, you’ll want to the marketplace outlook for the stock, in your decision-making process.
Anthony Caruso, CPA has practiced as a cpa and investment advisor for upwards of 3 decades. Caruso and Company, P.A. is a Registered Investment Advisor offering paid money management, tax and financial planning. Information contained above is not supposed to have been a suggestion to get or sell any specific investments, or take specific tax actions and individuals should consult with their advisors for appropriate advice concerning their individual circumstances.