Consider These Three Tax Planning Opportunities

With all the talk of higher taxes when the Bush tax cuts expire at the end of the year, it’s important not to become so focused on future tax policy that we overlook some short-lived opportunities.

• Prior to the implementation of the Jobs Growth and Tax Relief Reconciliation Act of 2003 (JGTRRA or the second Bush tax cut), dividends were taxed as ordinary income. With the passage of JGTRRA, qualified dividends became eligible for the more favorable capital gains rate of 15%. At the end of this year, however, the qualified dividend rules will sunset, and dividends will once again be taxed at ordinary income rates. At the same time, the highest tax bracket will increase from 35% to 39.6%, and high wage earners will be subject to a new 3.8% Medicare tax on investment income. Therefore, the dividend tax could shoot up to a high of 43.4%, not including state tax. This means owners of closely-held businesses have a unique tax planning opportunity to pay dividends this year and take advantage of the 15% tax rates.
• Until the end of 2012, couples with taxable income up to $70,700 (or $35,350 for individuals) do not have to pay capital gains tax. That presents a great opportunity for parents to gift appreciated stock to their adult children. (Remember, children over age 18 are not subject to the kiddie tax.) However, it’s important to watch that parents’ gifts of highly appreciated mutual funds or stocks don’t push the child into the next higher tax bracket.
• If you have been thinking about converting your traditional IRA (where distributions are taxed at ordinary income rates) to a Roth IRA (where, after five years, distributions are tax-free), 2012 may be the year to convert. Why? If you convert this year, you will be taxed according to this year’s tax rates, which are scheduled to increase across the board when the Bush tax cuts sunset at the end of the year.

As always, you should consult your accountant on these and other tax planning opportunities.

In the News -- USA Today & WTOP

The USA Today did a series of articles on insurance on Friday, March 25th, and I was a contributer to the article as noted below.  And WTOP Radio also called me at 6:50 AM this morning and asked a few questions about last minute tax planning ideas.

As published in USA Today
Common insurance pluses, pitfalls
Cutting back now can leave you in a lurch
By Christine Dugas USA TODAY
"As American families are struggling just to pay their bills, it’s not surprising that many are putting off life insurance. Individual life insurance hit a 50-year low last year, according to LIMRA, an industry-sponsored group.
But during tough economic times people should not sit back and think they’re immortal, says Gordon Bernhardt, a fee-only financial planner in McLean, Va."
Click here to read the full article 

Planning Amid Tax Uncertainty

Ben Franklin famously quipped that the only certainties in life were death and taxes. Of course, with the Bush tax cuts scheduled to sunset at the end of the year and the midterm elections capable of changing the balance of power on Capitol Hill, there is nothing certain about future tax policy. We can only surmise that taxes will, one way or another, likely increase at some point in the future.

If the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA)--the official names for the “Bush tax cuts”--sunset as originally legislated at the end of 2010, tax rates on ordinary income, long-term capital gains, and qualified dividends will revert to the higher, pre-2001 levels.

This table illustrates the differences in marginal tax rates after the sunset:

      Marginal Tax Rates         Marginal Tax Rates
                 for 2010                    as of January 2011
                     10%                                 15% (indexed and expanded)
                     25%                                 28%
                     28%                                 31%
                     33%                                 36%
                     35%                                 39.6%

Investors will also face higher capital gains tax rates. On January 1, 2011, the capital gains rate is scheduled to revert from the current maximum rate of 15% back to the 20% capital gain tax rate that was in effect prior to 2003.

Also, dividends which under the Bush tax cuts were taxed for the first time at the same low 15% rate as capital gains, will be reclassified and grouped with interest to be taxed at the higher rates levied on wages. In fact, unless Congress acts before the end of 2010, next year the top dividend rate will revert to 39.6% from 15%. That’s quite a leap.

What’s an investor to do? In anticipation of higher tax rates, if your portfolio includes appreciated assets, this year might be a good time to realize some gains at the maximum capital gains rate of 15%, rather than the 20% capital gains rate currently slated for 2011.

Investors in the 15% tax bracket or lower have a greater opportunity to save. For these investors, no gains are due on appreciated assets sold in 2010 if their gains are below a specified threshold. They would, however, be taxed at the 10% capital gains rate in 2011.

You should not, however, embark on a selling spree just to avoid what you think may be higher taxes down the road. Generally, you would want to have a purpose for the cash a sale would generate. For example, it may make sense to sell investments at gains this year if you have college tuition due next year for a son or daughter.  It also makes sense to sell individual, concentrated stock positions to adopt a more diversified and properly allocated portfolio.

If you are a business owner nearing your planned exit date, you may want to accelerate the sale of your business to avoid higher tax rates in the future.

And lastly, it is important to realize that the "wash sale rules" do not apply when selling an investment at a gain.  In other words, you can sell an investment today, record your gain, and buy it back immediately without waiting 30 days like you would when you harvest losses in your portfolio.

Economic and Political Pressures Will Influence Tax Policy

It is an interesting time in our nation’s capital. The latest polls show that the Republican Party may gain more than the 39 seats necessary to tip the balance of power their way in the House. Noting in a recent blog post that control of the Senate is also up for grabs, Washington insider and CNBC commentator Greg Valliere, said the Democrats need a “pre-election Hail Mary pass.”

Valliere floats the possibility for the following scenario: What if, now that lawmakers have returned to D.C., President Obama brings together leaders of both parties and negotiates a deal to extend the Bush tax cuts indefinitely for 97% of Americans, and perhaps for two or three years for the wealthiest Americans whom he initially targeted for tax increases?

While Valliere says a tax cut deal should be a “no-brainer” given the struggling economy, he expects politics to get in the way – on both sides of the aisle. He questions whether there are enough moderates who “recognize that this is a terrible time to raise taxes on anybody” and sees little possibility that the Republican leadership that has refused to compromise thus far would do so on an issue that has great potential to help them win seats and gain Congressional control this fall.

Only time will tell. However, in the meantime tax planning is a challenge as we are still unsure how tax policy will change next year.