The re-election of President Barack Obama, along with a Republican-controlled House of Representatives and a Democratic majority in the Senate, seems to leave Washington much as it was before, but big changes are coming for people who pay a lot of income taxes. the rent. .
Have you considered what you can do to put yourself in the best fiscal position as the current year ends and the new one begins?
A 0.9 percent increase in Medicare payroll taxes will apply to employees and the self-employed who earn more than $200,000 a year, and to married couples who earn more than $250,000 a year. The additional tax will only affect earned income, such as wages, salaries, and self-employment income, above these thresholds.
There is also a 3.8 percent tax on not won net investment income for high-income taxpayers. Unearned investment income includes interest, dividends, annuities, royalties, rents, and capital gains that are not derived in the normal course of business or operations. The tax is calculated on net investment income or modified adjusted gross income (often abbreviated as MAGI) above the $200,000/$250,000 thresholds above, whichever is less.
For example, let’s say a married couple has $300,000 of MAGI, including $70,000 of net investment income. The couple would pay the 3.8 percent ($1,900) tax on $50,000, which is the amount of investment income that pushes MAGI over the $250,000 threshold, instead of the full $70,000.
Of course, the year is not over. Something could happen to change these taxes as part of upcoming “fiscal cliff” negotiations, which include the expiration of Bush-era tax rates at the end of 2012. Or the taxes could be revised later as part of a larger review. wide. of the tax code, which both sides say they would like to consider in 2013.
Therefore, you may want to delay action for at least a few weeks, to see what happens before Congress takes its year-end recess. However, it is still important to have a plan in place so that you can act quickly if necessary. The big question is: What kind of plan should you develop? While the answer will depend on your particular situation, there are some logical strategies to consider. Here are some steps you can take to prepare.
Accelerate your income and defer your expenses.
If possible, you may want to take steps to carry over any income you would have received in 2013 to 2012 to avoid the new taxes. You may not have this option if you work for someone else, but it’s worth discussing with your employer, especially if you expect to receive a bonus in early 2013.
If you’re self-employed and think you’ll be affected, you can ask your clients to pay their end-of-year bills before the end of 2012. You can also delay buying expensive equipment or incurring other major expenses until 2013, to reduce revenue. and therefore exposure to the new taxes next year.
Maximize your retirement plan contributions.
Contributions to employer-sponsored plans reduce taxable income and may help reduce net investment income tax. For example, a couple that earns $275,000 and jointly contributes a total of $34,000 to their 401(k) plan reduces their taxable income to $241,000, bringing them below the threshold. Contributions to the Simplified Employee Pension (SEP), SIMPLE IRA, and other qualified plans would also be subtracted from taxable income.
Try to make capital gains this year and losses next year.
The remainder of 2012 may be the right time to sell appreciated investments in your non-retirement accounts, especially if you were planning to sell those securities in the near future anyway. The current maximum long-term capital gains rate of 15 percent will rise to 20 percent in 2013 unless Congress acts to extend the Bush-era tax cuts. So selling this year can save you up to 8.8 percent in tax.
While this may sound like a piece of cake, your particular situation will determine if it’s as good as it sounds. Take a close look at your portfolio and tax situation before taking any action. If you are not likely to be subject to the maximum capital gains rates in both years, or if you are likely to make significant losses next year regardless of tax strategies, your best course of action may be different.
In a related strategy, consider selling underperforming stocks in your taxable accounts and taking the resulting investment losses next year. Losses will offset your 2013 capital gains, plus offset up to $3,000 in ordinary income if your losses exceed your overall earnings. Taking losses next year will help you reduce your exposure to the new, higher taxes on both capital gains and earned income.
Change the investments that produce income.
If you’re not dependent on investment income generated in your taxable accounts, strongly consider keeping most of your income-producing securities in retirement accounts. Sell some of your interest- and dividend-paying securities in your taxable accounts and buy them back in an IRA or 401(k) account to minimize your exposure to the new tax rate.
You can also reinvest earnings in growth investments that pay little or no dividends and tax-exempt municipal bonds. This will reduce net investment income, MAGI, and taxes.
Try a fiscal triple play.
Consider giving appreciated income-producing investments to charities. You’ll get an income tax deduction for the fair market value of the security (as long as you’ve held it for more than a year), avoid capital gains tax, and reduce your future investment income.
Convert your traditional IRA to a Roth IRA.
Although distributions from traditional IRAs are excluded when calculating net investment income, they are included when calculating MAGI, which could increase your exposure to the new tax. With a Roth IRA, distributions are free of income taxes and are also excluded from both net investment income and MAGI.
The conversion amount is taxable income, but it may well be worth paying a one-time tax in 2012 to secure future Roth tax benefits, especially if: You expect your income tax rates to stay the same or increase in the future future; you will not need to access the Roth IRA assets when you retire; and you can pay the tax liability resulting from the conversion with non-IRA assets.
Not all of these strategies will be right for everyone, but if you consider them in the context of your situation, one or more may help you weather a change in the fiscal climate.