The uncertainty about future tax law makes 2012 year-end tax planning especially difficult. It feels a lot like 2010. As you may recall, the Bush-era tax cuts were due to expire at the end of 2010 and return to levels not seen since the year 2000. Then, at the last minute, Congress extended the then-current tax rates through 2012, with citizens and their financial advisors breathing a collective sigh of relief. Most of us thought that by the time December 2012 rolled around, Congress would have passed legislation to clarify tax law in future years.
Well, guess what? We are no closer to tax reform than we were in 2010, and if no action is taken before the end of this year, tax rates will return to 2000 levels. It’s possible that Congress may choose to extend current rates into 2013, as they are not planning on even discussing tax rates until after the election.
In July, we discussed 3 tax-efficient investing strategies (See: 3 steps to tax efficient investing) you may consider to potentially improve after-tax portfolio returns. However, given the uncertainty about what 2013 will look like, here are a few 2012 year-end tax planning ideas to discuss with your financial advisor or tax professional:
- Accelerate income — To the extent that you can control the timing of your income, it may make sense to accelerate income into 2012. The top marginal rate in 2012 is 35% (at the Federal level), while it is currently scheduled to increase to 39.6% in 2013.
- Roth IRA conversion — Up until now, many investors have been lukewarm about converting some (or all) of their regular IRAs to Roth IRAs, as you must pay income tax on the converted assets. This strategy, however, may make sense in 2012 for a few reasons. First, if you feel that tax rates may be higher in the future, converting to a Roth will generate income at current (lower) tax rates. Next, Roth assets do not have a required minimum distribution requirement, allowing more flexibility in distribution planning. Finally, Roth conversions can be “unwound” or re-characterized until October 15th of the year after conversion. Therefore, if you convert IRA assets to a Roth in 2012 and tax rates end up staying the same in 2013, you can unwind the transaction anytime until October 15, 2013.
- Realize capital gains — Depending on your situation, 2012 may be an optimal time to realize capital gains, especially if you have loss carry forwards from prior years. In addition, no matter what tax rates apply in 2013, a new 3.8% Medicare surtax will apply to capital gains for single taxpayers with modified adjusted gross incomes in excess of $200,000 and for couples over $250,000. Paying taxes in 2012 will avoid that surtax, regardless of whether or not the capital gains tax rates increase.
- Review gifting strategies — Year end is always a good time to make exempt gifts. The annual gift limit remains at $13,000 per donor per person, with a lifetime exemption of $5,120,000 and a top gift tax rate of 35%. If no action is taken before the end of the year, the 2013 lifetime exemption goes back to $1,000,000 and a top tax rate of 55%. If you are considering sizable gifts, consider accelerating them into 2012 to avoid potentially paying gift tax should these limits and rates revert to year 2000 levels. Another gifting strategy that often gets overlooked is that gifts made for tuition, medical expenses and medical insurance are exempt from gift tax, as long as they are paid directly to the provider (such as the school, doctor or insurance company).
- Consider intra-family loans — With interest rates at historic lows, loaning money to family members can be an effective estate planning technique to consider. These loans must carry interest at the applicable federal rate (AFR) in order to avoid being classified as a gift. The current long-term AFR for loans more than nine years is 2.18% (compounded annually), and the short-term AFR for loans less than three years is only 0.21%. If you are hesitant to make outright gifts to your children or grandchildren, this might be a good option. Remember that these loans must be documented and treated as an arms-length transaction in order to avoid being considered a gift. Working with an estate planning attorney for these kinds of transactions is always a good idea.
- Review charitable giving — One of the tax reform proposals Congress is considering would limit the tax benefit of charitable contributions for high income taxpayers, so it may make sense for you to accelerate some of your future charitable contributions into 2012. If you have low cost basis securities, making contributions using these securities rather than cash may offer two advantages. First, donating appreciated property to most qualified charities avoids capital gains taxes on the appreciation. Second, it gives you a tax efficient way to diversify your concentrated or low basis positions. The deduction for donating appreciated property to most charities is limited to 30% of adjusted gross income, but excess contributions can be carried forward five years.
- Refinance mortgages —You may find it preferable to refinance from a 30-year loan to a 15-year loan, as some institutions are offering 15-year loans at less than 3%. The payment on a new 15-year mortgage may be similar to your existing 30-year mortgage and would significantly reduce the amount of interest you pay over the life of the loan.
- Review beneficiary designations — This is the perfect time to work with your advisor to review all beneficiary statements for 401(k) plans, IRAs, and life insurance policies. You may not be aware that retirement account assets pass by beneficiary statement and not by will; the same is true for life insurance policies. Every estate planning attorney has stories of clients who divorce and never revise their beneficiary statements; the client dies and a life insurance policy or 401(k) plan is paid to the ex-spouse, leaving a current spouse or children with nothing.
These are just a few 2012 year-end tax planning ideas — your financial advisor in Richmond, Va or tax professional may be able to provide more specific suggestions for your particular situation.
About the author: Katherine Fonville is an independent Financial Advisor in Richmond, Va helping clients with investment management, retirement planning, estate planning, college planning, and financial planning needs. Always consult with your tax advisor prior to implementing tax strategies.
Fonville Wealth Management, LLC is not an insurance, legal or tax advisor. The 2012 year-end tax planning ideas herein are general in nature and should not be considered insurance, legal or tax advice. Individuals should consult an attorney or tax advisor for specific information on how tax laws apply to their situation. Laws of a particular state or laws that may be applicable to a particular situation may have an impact on applicability, accuracy or completeness of information contained in this newsletter.