As many readers know, the so-called “Bush tax cuts,” originally scheduled to expire in 2010, have been extended by Congress until the end of 2012, due to the weak economy. The President and Congress have been loath to raise taxes while the economy is still weak. But unless Congress changes the law, the Bush tax cuts are slated to expire at the end of the year.
Here’s what you can expect:
- Income taxes on every dollar you make over $70,700 are going to increase from 25 percent to 28 percent.
- Income taxes on every dollar you make over $142,700 are going to from 28 percent to 31 percent.
- Income taxes on every dollar you make over $217,450 will increase from 33 to 36 percent.
- Taxes on every dollar you make over $388,350 will increase from 35 percent to 39.6 percent.
- If you own stock, the top tax rate on dividends will increase from 15 percent to 43.4 percent
- The top rate on capital gains will increase from 15 percent to 23.8 percent. (The last two items include a 3.8 percent surtax under the Affordable Care Act.)
- The estate tax rate (the so-called “death tax”) will increase by nearly 60 percent, from 35 percent to 55 percent.
- Payroll taxes will increase by 2 percent, as employers must withhold an extra 2 percent of wages from workers’ paychecks. Workers will essentially receive a 2 percent cut in buying power.
These are just the taxes that directly affect individuals. There are other taxes that will primarily affect corporations, such as the surtax on medical device manufacturers, under the Affordable Care Act, that will make their effects known via hiring slowdowns.
Here’s what I don’t expect:
I don’t expect a meaningful and lasting fix to the alternative minimum income tax, which is affecting more and more middle-class taxpayers every year. Back in 1969, when it was first enacted, the AMT was originally designed to affect only the very wealthiest taxpayers. The real “1 percent.” But now it’s become too big a line item on the Federal budget. Congress, like a junkie, is addicted to that money.
I don’t expect the two parties to get along very well – especially as we approach negotiations over the debt ceiling, which could well lead to a government shut-down next year.
So what are we suggesting our clients do?
- Look for ways to sell off winning positions this year. Do it early, before last-minute sell-offs depress prices. That will help you pay capital gains at this year’s rates, rather than next year’s.
- Consider a Roth IRA conversion. With a Roth IRA, you’re essentially paying this year’s tax rates, rather than exposing yourself to future tax rates.
- Look at life insurance ideas. If you have substantial cash flow to invest, life insurance cash value accumulates tax free, and you can draw it down tax-free to supplement retirement income. Essentially, it’s taxed the same as a Roth. Now, it doesn’t make much sense if you don’t need or want that permanent death benefit. But with estate tax rates slated to go up sharply, a lot of families are going to need that death benefit to raise the cash to pay off Uncle Sam someday – without having to hold a fire sale on your legacy.
- Speaking of estate planning, start working on it now. There are certain things you can’t do at the last minute. A strategic gifting program, for example, works much better spread out over a number of years.
- Fund that Section 529 college savings plan. You don’t get a tax deduction on those, so this year’s the year to fund it as much as you can. Withdrawals for qualified educational expenses are tax-free, so the later higher income tax rates don’t hurt you.
- Fund the Roth IRA. Same idea. If you are trying to choose between a Roth IRA and a traditional, and you’re on the cusp of either one, fund both. But consider fully funding the Roth this year and the traditional next year, assuming you qualify, rather than trying to split contributions in both years.
- Assess your expected AMT situation, both for this year and for next year. There may be some deductions you won’t qualify for next year, thanks to the AMT. You may find out you need to bunch your deductions in one year or the other. Start looking ahead.
Lastly, make an appointment! These ideas are just some of the things we’re looking at with our clients. Not all of them will make sense for everyone. Decisions like life insurance funding and IRA conversions are highly dependent on individual situations. That’s why it’s important to crunch the numbers in light of your individual financial situation and objectives.