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Financial planning in advance of Bush-era tax cut expirations

hillDavid112912_optRates scheduled to rise

BY DAVID M. HILL
COMMENTARY

The expiration of the Bush tax cuts will indeed happen on Dec. 31. But will they be extended? Many believe they will not. What this means is that effective Jan. 1, 2013, taxpayers who are now taxed at a maximum of 33 percent, will be taxed at 36 percent, and taxpayers now taxed at a maximum of 35 percent will be taxed at 39.6 percent. Additionally, long-term capital gains will be taxed at 20 percent and dividends and short-term capital gains will be taxed as ordinary income.

Our usual advice to defer gains until next year is out the window for the most part, considering these developments. What you may want to consider right now, in light of the fact that these new rates will in all likelihood go into effect, is to take some gains this year before the tax rates are due to rise.

And even if the Bush-era tax cuts are extended, there’s always the Medicare surtax to plan for. A 3.8 percent surtax will be imposed on individuals, trusts, and estates if certain thresholds are met. (Click here for Brinton Eaton’s recent blog on this topic.) This change is also scheduled to begin with the 2013 tax year.

On top of it all, there will be another Medicare surtax in addition to the 3.8 percent. Effective Jan. 1, 2013, an extra 0.9 percent Medicare tax will be levied on employees and self-employed individuals earning over $200,000 ($250,000 for married couples and $125,000 for married couples filing separately).

All in, the new Medicare tax will raise the marginal income tax rate for those taxpayers who fall into the higher income levels. The key to minimizing the new surtax is to reduce your net investment income. Among the investment choices you may want to consider are tax-free municipal bonds and tax-deferred annuities as well as certain tax strategies. For example, you want to contribute money to your IRA before April 15, 2013 and/or accelerate any taxable income into this year. There are different strategies that you can employ depending on your personal situation — your financial or tax advisor can provide details.

Another important change to take note of is the planned increase in the estate and gift tax exemptions. With the $5 million exemption reduced to $1 million on Jan. 1, 2013, it might be advisable to make last minute gifts before the law goes into effect next year.

While, generally speaking, you may want to accelerate any income and large gains into 2012 with the increase in 2013 rates, everything you do should be done thoughtfully and in accordance with your objectives. For example, don’t just sell to lock in lower rates; you could be jeopardizing certain aspects of your long-term financial goals. Consult your financial advisor about the best course of action for your specific situation.

David Hill, CFPTM, is a financial advisor at Brinton Eaton, an SEC-registered investment advisory firm in Madison, N.J.

 

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