Year-End Planning Amidst Tax Uncertainty

This is the time of the year we traditionally remind our clients age 70 1/2 or older or those with inherited retirement accounts to take any required minimum distributions from retirement accounts, consider harvesting losses to shelter current or future capital gains and to consider other portfolio-related tax strategies.  This year’s tax planning is more difficult but potentially more important given the scheduled expiration (“sunset”) of the Bush-era tax cuts.  While President Obama has made clear his preference to allow the tax cuts to expire for the wealthy, no one yet knows what compromise might be made as part of a fiscal cliff negotiation.   Accordingly, the best you can do is to create your “what if” plan so that you can be ready to make last minute moves if such moves might save you taxes if tax increases are imminent.

Changes on the Horizon

If the Bush-era tax cuts expire, federal income taxes will rise across the board with the top marginal tax rate rising to 39.6% from 35%.  Taxes on capital gains and dividends will also rise with the top capital gains rate rising from 15% to 20% (or 23.8% for those subject to the Medicare surtax, discussed below), and the top dividend rate jumping from 15% to 39.6% (43.4% for those subject to the Medicare surtax, discussed below).  With sunset, the historically favorable wealth transfer laws also expire in 2013, with the ability to transfer wealth free of gift or estate tax returning to $1M from its current $5.12M level and the maximum tax rate returning to 55% from its current 35% level.
Sunset or no sunset, high-income taxpayers face new Medicare taxes stemming from the 2010 health care overhaul that kicks in next year imposing an additional .9% Medicare tax on wages/salary and self-employment income exceeding $200,000 ($250,000 married filing jointly).   Additionally, taxpayers with modified adjusted gross incomes in excess of $200,000 ($250,000 married filing jointly), whether the income is earned or unearned, will also have some or all of their unearned income subjected to an additional 3.8% Medicare surtax.   The 3.8% surtax will be imposed on the lesser of the net investment income or the amount by which modified adjusted gross income exceeds $200,000 ($250,000 married filing jointly).  This means that a married couple filing jointly with a modified adjusted gross income of $300,000 exceeds the threshold by $50,000 and would be subject to an additional 3.8% surtax on up to $50,000 of net investment income, but not be subject to the surtax to the extent they do not have net investment income.

Your “What If” Plan

We encourage you to meet with your tax advisor now to develop your plan of action if the Bush-era tax cuts expire.  If expiration seems imminent you might want to sell assets, accelerate income (including bonuses) or make gifts you might have otherwise put off.   You might also want to defer selling capital assets at a loss or taking other deductions into later years when they might be more valuable if it appears that the Bush-era tax cuts will expire and taxes rise.
Should you sell positions with built-in gains before taxes rise?   Tax consequences alone should not control your decision to sell an asset, but if you have appreciated positions you plan on selling or would otherwise be forced to liquidate in the next year or two to meet expenses, you might want to be ready to sell this year if the capital gains rate will rise by 5% in 2013, especially if your MAGI is above the threshold and your capital gains would also be subject to the 3.8% Medicare surtax next year.  This means that a sale of appreciated positions with $500,000 of gain in 2012 might save you as much as $44,000 ($500,000*8.8% (5% additional capital gain and 3.8% Medicare surtax if applicable).
Regardless of tax cut extension, if your MAGI is above the threshold you might consider harvesting gains now to avoid paying next year’s surtax on appreciated positions you would otherwise sell in the near future.   Since the wash sale rules don’t apply to gains you might even immediately repurchase the holdings sold if still appropriate for your portfolio.
Should You Convert Your Traditional IRA to a Roth?   Investments in a Roth IRA grow tax deferred and qualified withdrawals are income tax-free, but the tradeoff is that the funds converted trigger current ordinary income taxation.   If you had been contemplating a Roth conversion, you should talk to your tax advisor about hastening a potential conversion if it appears taxes will rise to reduce your tax bill on the conversion.  Roth conversions tend to make economic sense if (1) you have monies outside of your IRA to pay the income tax, (2) you believe you’ll be in a higher income tax bracket in your retirement years, and (3) you have more than a decade before you’ll need to use the funds to allow for tax-free compounding or you plan on leaving your IRA to your heirs.  A conversion might also be beneficial if you are retired and your required minimum distributions from IRAs or qualified plans would otherwise push you over the $200,000 ($250,000 married filing jointly) MAGI threshold when combined with other income such as Social Security subjecting your net investment income to the 3.8% additional Medicare surtax as the conversion might keep your MAGI under the surtax triggering threshold.   Note that if you convert you might have until October 15, 2013 to recharacterize the conversion.
Should You Make A Significant Gift?  If your estate is on the larger side, and you can afford to make a significant gift without impacting your own lifetime needs, your window to gift as much as $5,120,000 ($10,240,000 married) might close as the exclusion returns to $1,000,000 in 2013 absent Congressional action.  The earlier you remove assets from your estate the more effective you will be maximizing the transfer to your heirs as you can remove the asset and all future appreciation on the asset from your estate.  Please let us know if you need help determining whether you might afford to make a significant gift and still meet your lifetime needs.  There are many ways of taking advantage of the increased gift tax exclusion, but the clock is ticking on your ability to gift as transfers of this magnitude take time and many estate attorneys are not taking additional clients for fear that they will not be able to complete promised transfers by year-end.

Other Moves to Consider

Maximize your IRA and Retirement Plan Contributions.  Regardless of whether taxes increase next year, tax-deferred growth results in faster growth of your retirement funds.    The IRA funding limits for 2012 are $5,000 ($6,000 if over age 50) and the elective deferral limits to 401(k), 403(b), and 457 plans are $17,000 ($22,500 if over age 50).
Annual Exclusion Gifting.  The clock is also running on your ability to take advantage of annual exclusion gifting for 2012.  The annual exclusion allows you to make tax-free transfers of $13,000 in cash or property (such as securities) to anyone without reducing your ability to shield future wealth transfers from tax using your gift and estate tax exemptions.   If you have three children, this means that you could gift $39,000, each year or you and your spouse could collectively give $78,000 each year.
The annual exclusion gift can be used in many ways including making gifts of cash to fund a tax-advantaged Section 529 college savings plan to fund a child or grandchild’s education.  You can even retain ownership of this account and access the funds for your own non-educational use later if needed (subject to penalties) while transferring the account outside of your estate.  Alternatively, if your child is working and you would like to help him or her save for retirement, your annual gift of cash might allow your child to fund a Roth IRA as your employed child might fall under the income limitations that typically prevent you from contributing to a Roth IRA.  Specifically, in 2012 a single, employed child can use $5,000 of your gift to fund a Roth IRA, reduced by any other contributions to an IRA.  Your child must have earned at least $5,000 in 2012 but not more than $125,000 (single taxpayer) to be eligible for the contribution with a reduced contribution amount if he or she earned more than $110,000.   You would want to make the cash gift this year, but your child has until April 15th of 2013 to open and fund the Roth IRA.
Gift Appreciated Stock to Charity.  If you are planning to donate to charity this year, talk to your tax advisor about making your donation with highly appreciated securities rather than cash.  For a gift to a public charity, not only are you allowed to take the income tax deduction for the full value of the securities (subject to the 30% AGI deduction limit with overage carried over for 5 years) you also avoid the capital gains tax you would otherwise pay on the sale of those securities.  The charity can sell the securities without paying tax and use the proceeds for its own purpose.   Please let us know if you would like to gift appreciated securities as it takes some time to facilitate the transfer.
As always, Beacon Pointe is available to help you address any tax concerns that you may have for this year with respect to your portfolio.  We will work directly with your managers and tax advisors regarding your specific situation.   Do not hesitate to call us with any questions or to discuss steps you would like taken in your portfolio.
All the best for the remainder of 2012!

Disclaimer: This has been provided for informational purposes only and should not be considered as investment advice or as a recommendation. Beacon Pointe does not endorse and is not responsible for the content, product, or services of other third party sites or references. Beacon Pointe does not offer legal or tax advice.  Private legal counsel alone may be responsible and relied upon for these purposes. Only private legal counsel may recommend the application of this general information to any particular situation or prepare an instrument chosen to implement the design discussed herein. CIRCULAR 230 NOTICE:  To ensure compliance with requirements imposed by the IRS, this notice is to inform you that any tax advice included in this communication, including any attachments, is not intended or written to be used, and cannot be used, for the purpose of avoiding any federal tax penalty or promoting, marketing, or recommending to another party any transaction or matter.

Important Disclosure: This content is for informational purposes only. Opinions expressed herein are subject to change without notice. Beacon Pointe has exercised all reasonable professional care in preparing this information. Some information may have been obtained from third-party sources we believe to be reliable; however, Beacon Pointe has not independently verified, or attested to, the accuracy or authenticity of the information. Nothing contained herein should be construed or relied upon as investment, legal or tax advice. Only private legal counsel may recommend the application of this general information to any particular situation or prepare an instrument chosen to implement the design discussed herein. An investor should consult with their financial professional before making any investment decisions.

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