Year-end tax planning…a conundrum of sorts

Spotlight on Finance

— On top of these changes, the 2010 health care reform legislation adds an additional 3.8 percent Medicare tax on the unearned income (interest, dividends, capital gains, rent, etc.) of high income taxpayers (income in excess of $200,000 for individuals/$250,000 for married couples).

These are significant changes that will ultimately touch all Americans in one form or another. The question is: will lawmakers keep on the current course despite the CBO report? If the bridge is out ahead, will the economic bus keep going? Maybe. Maybe not.

The tax planning conundrum

There’s not a lot of time left, but Congress can still act. Here are a couple possible scenarios:

  1. Congress can eliminate some or all of the scheduled tax cuts set to expire and remove some of the target cuts in defense and nondefense spending.
  2. Lawmakers could opt to work from the middle and address budget issues on a limited basis, mitigating the impact on the economy. Since Congress has opted to delay any changes regarding spending or the removal of tax cuts until after the election, an agreement has to be reached in a matter of weeks. And here lies the conundrum. If the economic bus keeps on its current course, the general rule-of-thumb for tax planning—delay income and accelerate expenses—gets thrown to the side of the road. Instead, taxpayers need to take the following steps now to help ease the pain later.
  • Accelerate income and long-term capital gains.
  • Postpone losses and deductions.
  • Convert non–deductible debt to deductible debt.
  • Consider a Roth IRA conversion.
  • Exercise employer stock options.
  • Maximize retirement plan contributions.
  • Take advantage of tax diversification and asset location strategies.
  • Use tax-exempt municipal bonds for fixed income allocation in taxable accounts.
  • Consider partial allocation to cash value life insurance.
  • If gifting, consider income-producing assets.

We can’t predict whether Congress will act to change these tax laws. Time will tell, but there’s not much time left. So taxpayers need to buckle up and keep their eyes on the road ahead. And given that 2012 income tax rates are historically low and taxpayers are faced with potential rate increases, it’s important to compare your current tax situation with a projected tax scenario under the higher tax regime. Doing so will allow you and your advisors to determine which strategies are best for your individual circumstances.

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