Lately, I have spent some time reading articles where pundits theorize about what will happen with the income tax rates for 2011 and beyond. Most believe that because the national debt has gotten so large, a tax increase is inevitable. Perhaps that tax increase will only be to let the Bush tax cuts of 2001 and 2003 expire, but that alone will result in a large increase in taxes for most Americans.
If we return to the tax rates of 2001, the highest tax bracket will increase from 35% to 39.5% and the maximum capital gains rate will go from 15% to 20%. In addition, qualified dividends would no longer be taxed at the capital gains rates, but would be taxed at the higher ordinary income rate.
Additionally, the estate tax, which disappeared this year, will come back at the 2001 rate, which allowed an exclusion of only one million dollars. That would place many people who own a relatively modest home and a fair-sized retirement plan (certainly not the amount that financial planners are recommending these days) subject to estate tax. A tax designed only for the super rich would ensnare many “ordinary” Americans.
Assuming the anticipated changes take place, it would be advantageous to do some advanced tax and financial planning. Please schedule a consultation with both your financial advisor and your tax advisor prior to implementing any of these suggestions.
Capital Gains/Capital Losses
Review your capital gains and losses for 2010. If you have a net gain, check your 2009 tax return to see whether you have a capital loss carryover that could offset 2010 gains. Usually, we advise that you use your capital losses to offset gains to minimize the tax impact. This year, however, you may want carry over as much of the loss as you can to use against probably-higher tax rates for 2011 and beyond. In fact, this might be a good year to harvest capital gains while the rates are still low. You might want to see stock, pay taxes at the current maximum of 15% anticipating that if you wait, you will in all likelihood pay at least 20%. If you really like the stock, and it has done well for you, you can always re-purchase it and have the higher basis for the newly purchased stock.
Retirement Income
If you are currently taking distributions from a retirement account, you may want to take a bit more in 2010 and then take less in 2011. That way, you will pay less in tax on the amount you take out in 2010 for use in 2011. Of course, you will still need to take the minimum required distribution.
If you are over 59 ½ and under 70 ½ and, therefore, not subject to an early withdrawal penalty and not subject to required minimum distributions, you may want to take a distribution in 2010 so that it is taxed at the current rates and put it into an account that you do not tap until you reach 70 ½.
Converting Roth IRAs
For this year (2010) only, if you convert a Roth IRA, you can elect to pay all the taxes for 2010 or defer the taxes and pay over two years–2011 and 2012. In normal times, it would be suggested that you defer payment as long as possible, but if rates do go up, you will want to pay the entire tax at the lower 2010 rates. (Some advisors believe that you will be taxed at the 2010 rate regardless of when you choose to pay, but the IRS has not issued regulations regarding how this will be handled.)
Bonuses, Stock Options
As a rule, people defer income into a future year so that they pay taxes on that income in the future. If, however, rates are going to go up, it would be advantageous to take your bonus in 2010 and exercise your stock options in 2010 while the rates are relatively low. This is especially true for those in the higher tax brackets.
Medicare Surtax
Although this does not go into effect until 2013, it is worthy of consideration now. First, it is really two surtaxes.
First, there is a 0.9% levy on earned income from both wages and self-employment for earnings over $200,000 (singles. $250,000 married filing joint). Rather, than the usual 2.9% Medicare tax, the tax will be 3.8% for those “high earners”.
As an aside, those who are self-employed will not be allowed to deduct this surtax as part of their deduction of ½ of self-employment tax, resulting in higher income taxes.
Second, there is a special 3.8% surtax on unearned ( dividends, rental income, interest, etc.) income of single filers with incomes over $300,000 and joint filers with incomes over $350,000.
Although these increases disproportionately hit high wage earners, they will affect almost every tax payer. This year, in particular, it will pay to plan ahead.
