NEWS AND RESOURCES

Financial Planning for November 2012

Year-End Tax and Portfolio Tips

One day, we might find ourselves looking back at 2012 as the grand old days of tax planning. While the 2010 Tax Relief Act’s lower rates could be extended next year, it is likely some tax breaks will hit the chopping block, be it specific deductions or investment income. Furthermore, the 2 percent payroll tax cut we currently enjoy will probably go away, with an additional 0.9 percent Medicare surtax scheduled to take its place.

If possible, this is an ideal time to see if you can accelerate any 2013 income into this year by paying yourself future compensation in advance or conducting a Roth IRA conversion.

The Bush tax cuts reduced the capital gains tax rate from 20 percent to 15 percent – a rate scheduled to return to 20 percent at year’s end. Taxes on dividends are also scheduled to return to ordinary income rates in 2013, with a top rate as high as 39.6 percent. Thus, if you have any highly appreciated assets or dividend-producing investments you’ve thought about selling to take and reposition profits, this would be a good time to do so. You have until year-end to sell and be liable at the lower tax rates; if you wait until next year, your liability will likely increase substantially.

How much will it increase? In addition to the rates scheduled to return, the capital gains tax will be subject to an additional 3.8 percent Medicare tax imposed by the Health Care and Education Reconciliation Act of 2010 for single taxpayers with income over $200,000 ($250,000 for married taxpayers). This means that starting on Jan. 1, 2013, the total capital gains tax rate will increase to 23.8 percent.

Estate Planning

From an estate planning perspective, today’s higher gift tax exclusions make 2012 a particularly good year to take advantage of the higher limits for lifetime gifts to children and grandchildren. Currently, the estate and lifetime gift tax exemptions are $5.12 million per person ($10.24 million per couple) with a 35 percent top tax rate on amounts that exceed those thresholds. Beginning in 2013, these exemptions are scheduled to drop to $1 million per person ($2 million per couple) with the potential top tax rate of 55 percent.

Consider that making gifts during your lifetime offers several advantages:

  • The assets you transfer while still alive are removed from your estate (and subsequent estate taxes).
  • Any future appreciation that could be earned by these assets would also be removed from your estate.
  • That potential future income is shifted to your loved ones, who may be able to keep more of the income generated if they are in a lower income tax bracket.
  • The transferred assets and their subsequent appreciation would also be protected from potential creditors, lawsuits or divorce proceedings.

If you are interested in making a substantial gift but are uncomfortable relinquishing complete control over the assets, consider placing your gift in a trust. Speaking of which, you can use a trust strategy to benefit from today’s lower real estate values. For example, you could transfer a piece of property – such as a family vacation home – to a Qualified Personal Residence Trust (QPRT). The present-day value of the home is considered a taxable gift that would count against your $5.12 million lifetime gift tax exemption. If you are still alive when the QPRT term expires, ownership of the property would transfer to your heirs without incurring gift or estate tax consequences. Note, however, that should you die before the term is up, the property would remain part of your estate and be subject to estate taxes.

The current favorable tax environment offers many strategies that can help you position your assets for the future. Regardless of who sits in the White House next term, it might be wise to take advantage of today’s lower rates before they are scheduled to expire at the end of the year. Be sure to consult with a tax advisor and/or experienced estate planner to see which year-end strategies would work best for your situation.

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