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End of the year tax advice: What to do over next few days

moneylogo070510_optBY WARREN BOROSON
NEWJERSEYNEWSROOM.COM
BOROSON ON MONEY

So, how did all those recent complicated tax changes affect you?

First, there's no rush for you to sell your winners. While it's sensible to believe that Federal taxes will go up sharply in the future, they won't go up in 2011 or 2012.

As Jay J. Freireich, a lawyer with Brach Eichler in Roseland, puts it, Congress was supposed to end the uncertainty about tax matters; instead, it punted for two years. Tax brackets and capital-gains taxes remain unchanged.

So you can keep your winners.

Second, because Federal taxes will remain the same over the next two years, there's no huge incentive for you to buy municipal bonds.

Third, you should seriously consider converting a regular IRA to a Roth IRA before the end of this year — during the next week. I've done it myself.

FreireichJay122710_optWith a regular IRA, your money grows untaxed — until you withdraw it. Then you pay taxes at your tax level. With a Roth, you pay as you go in, not as you go out. That's better, of course, if tax rates remain as low as they are now and if rates go up in the future.

There are two other key benefits of a Roth IRA.

1. For this year only, you can split your withdrawal taxes evenly between 2011 and 2012, or pay them all in 2010. Paying them over the next two years means you get to keep more of your money over a longer period of time. Always nice.

2. You don't have to take minimum distributions from a Roth IRA. So your inheritable estate can grow and grow — and your heirs will become richer and richer. (Presuming that whatever you invested in does well.)

By taking minimum distributions, you're shrinking the value of your tax-deferred account.

Of course, if you'll be in a lower tax bracket when you withdraw money from your IRA, whether or not tax rates go up, converting may not be so terrific an idea.

Here's an example that Freireich gives:

Let's say you have a $1 million IRA, and you're 70 ½. And you live to 90 ½. You must pull out 1 / 27.4 the first year, 1 / 26.5 the second year, and so on in accordance with the IRS table (unless you are married to a spouse more than 10 years younger than you). As you get older, assuming a 5% growth rate, that $1 million fund would drop down to $850,000 and your kids would need to pay taxes as they pulled it out over their life expectancy.

If the million is sheltered in a Roth, with 5%-a-year tax-free growth over 20 years, that fund would first decrease to $700,000 (assuming a 30% bracket), but would then increase to $1.85 million — even after you've pulled out the tax money to pay taxes due on the conversion. And your kids would not need to pay taxes when they pulled it out over their life expectancy.

"That's a huge difference," he points out.

In my own case, I've converted a little, and plan to pay the taxes in 2011 and 2012. I might be in a lower tax bracket then; besides which, I want to leave more to my heirs.

***

Okay, where are you going to get money

to pay those taxes you owe for turning a regular IRA to a Roth?

Fact is, your Social Security contribution will shrink a bit: 2 percentage points. Uncle Sam wants you to have some extra money to spend, so you'll help goose the economy out of the doldrums.

You might use the spare money to pay the taxes due on your converting a traditional IRA to a Roth.

Why the reduction? Freireich believes it's to stimulate the economy; but if it doesn't work, it could make Social Security go bankrupt sooner rather than later.

Why the two-year deferral of important changes?

Says Freireich, "Everyone in Congress is afraid to do anything for more than two years, waiting for the results of the 2012 elections. So, ‘Let's see what happens in the next Presidential election and then we can circle back.' If the Republicans win, they would likely favor keeping the tax rates low. If the Democrats come into power and actually have power, then presumably they would increase the tax rates on people earning above $150,000 for singles, above $250,000 for married couples."

Other changes that might influence your conduct during the remaining days of 2010:

You can now expense certain business equipment in full in the year of purchase, rather than over five years. A good way to lower your 2010 taxes — if you could use some new business equipment.

Also: For 2010, the generation-skipping tax on gifts is zero percent. For 2011, it's 35%.

"For someone making a generation-skipping transfer, like a grandparent to grandchild," says Freireich, "this may be the year to do it. But be aware of the gift tax on gifts over $1 million."

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