Taxpayer Relief Act of 2012: 5 Key 2013 Retirement Planning Points

The House of Representatives passed a previously-passed Senate bill (H.R. 8), a 157-page bill called the American Taxpayer Relief Act of 2012. There are many retirement planning provisions included in the bill that kept the United States from plunging off the fiscal cliff (cue scary music, plus the equally-scary reality that another showdown over spending cuts and deficit reduction is looming on the horizon).


One key word struck us as we extensively combed through the piece of legislation: permanent. Many of the provisions we discuss in the video below were made permanent, meaning we may have some concrete planning guidance moving forward.

To help you begin to think about 2013 planning, we broke down the lengthy piece of legislation into 5 key 2013 retirement planning points. We list them and go into more detail in the video below. Also, make sure to subscribe to our YouTube page, IRAtv, for future alerts each time we post a new informative video.

One subject we don't touch on in the video (Qualified Charitable Distributions) was a popular topic found in our inbox at year end, and the Taxpayer Relief Act of 2012 answers many of the questions involving QCDs. As a programming note, Beverly DeVeny will discuss QCDs at length in this space on Friday, so check back for that.

5 Key 2013 Retirement Planning Points

• Income tax rates
• Permanent estate tax exemption
• Permanent capital gains rates
• Index of inflation for AMT patch
• In-plan Roth conversion CHANGE

-By Jeffrey Levine and Jared Trexler

Read More

Accelerating the Sale of Appreciated Capital Gain Property: A Strategy Worth Considering

As you are now no doubt aware, there are any number of ways which you might pay more in taxes for 2013 than you will this year (in case you missed it, click here to read my article on 10 of those ways). One of those many ways is when you sell long-term capital gain property. Common types of capital gain property are stocks, bonds, mutual funds and real estate. To be considered “long-term,” you must have held the investment for more than one year.

Currently, the maximum rate you will pay on the sale of most long-term capital gain property is 15% of the gain. Next year, that’s scheduled to jump to 20% (a 33% hike), and if your unfortunate enough to get hit with the new 3.8% health care surtax as well, you could pay up to 23.8%, which is almost 60% more in tax than you would ever have to pay this year!

One of the nice things about investing though is that you can, in some ways, control your tax liability. For instance, suppose you purchased $10,000 of XYZ Corp. in your regular brokerage account several years ago. Now that stock has appreciated in value and is worth $20,000. How much tax do you owe? You might be tempted to say $1,500 (15% times your $10,000 total gain), but that wouldn’t necessarily be the case. In fact, it would only be the case if you chose to sell your investment. That’s because during the time you own a capital investment, such as a stock, bond, real estate, etc., gains and losses are generally deferred.

Most people - including most CPAs - try to put off paying taxes for as long as possible, and usually that’s a good thing. After all, isn’t that the reason so many of us contribute to a traditional IRA, 401(k) or similar type of tax-deferred account? As a result, people often hold onto investments for long periods of time. In fact, sometimes people are so averse to paying tax that they hold onto an investment long after they should, perhaps incurring investment losses that far exceed any tax they would have paid.

If, however, there was ever a time to sell appreciated property before you otherwise intended to, it could very well be now. Why not sell your long-held investment now and lock in the low 15% rate still in effect through the end of this year? Sure, you will be paying taxes before you have to, but you could be paying them at a significantly lower rate than you would in the future. In some sense, it’s
very similar to a Roth IRA conversion, where you pay taxes on your retirement account sooner than you would otherwise have to, but with the idea of locking in today’s “low” tax rates in the process.

What if you really like a stock and don’t want to be without it? No problem. You could sell your XYZ stock at 10:00 AM tomorrow to lock in the current 15% long-term capital gains rate and buy it back one minute later at 10:01 AM. You might be thinking to yourself right now, “Isn’t there some sort of rule stopping me from doing that? Don’t I have to wait more than 30 days or something like that?” If this thought is running through your mind, you’re probably thinking about the “wash sale” rule.

Fortunately, in our example, the wash sale rule doesn’t apply. The wash sale rule deals with losses, but here, we’re talking about selling investments with a gain. When/if you repurchase the same investment, your new cost basis will be the amount you paid when you repurchased it. Any future gain could still be taxed with the 20% rate - 23.8% with the surtax - but the tax would only apply to the gain above your new, higher basis.

Should you choose to take advantage of this strategy, I have one additional suggestion. Consider using non-investment money, such as money in a savings or money market account, to pay the tax. You’re probably not making much in the way of interest on those funds these days and this way, if you decide to reinvest your funds, you’re not reducing the amount to be invested by the tax you voluntarily chose to accelerate paying. You should not, however, leave yourself without enough money to meet your ongoing expenses and cover yourself in the event of an emergency.

Of course, like most planning strategies, this idea is not for everyone. Here are four groups of people who should probably not “sell early” to lock in today’s cheaper tax rates.

#1 - You expect to be in the lowest brackets in the future
If you expect your income to decrease substantially in the future, you may not want to sell your long-term capital gain property now. Although the maximum rate you could pay on the gain is 20%, plus an additional 3.8% for the health care surtax, if your income is fairly modest, you might owe as little as 10%.

#2 -You’re terminally ill
It’s hard to write about stuff like this, but it’s also an important consideration. If you are very ill and probably won’t sell your investment before you pass, you’re probably better off holding onto it. Capital assets receive what’s known as a “step-up in basis” after death. This means that whatever the value is on your date of death, that’s your heir’s new basis. So let’s assume you bought a building in 1950 for $50,000 and now it’s worth $2,000,000. If you sell the property before year-end you’re looking at close to a $300,000 tax bill. That’s better than it would be next year, but, on the other hand, assuming it’s still worth the same $2,000,000 at the time of your death, your heir could sell it for that price and pay no income tax whatsoever.

#3 - You’re never going to sell
This is really kind of an extension of #2. If you plan to hold your investment forever, there’s no point in selling now. Remember, if you never sell a capital investment, you’ll never trigger the capital gains tax, no matter how much gain you have. Plus, as noted above, when you ultimately pass those assets to your heirs, they will get a step-up in basis and may be able to sell the property on their own with little or no tax consequence.

#4 - You’re going to give it away to charity
When most people think about making charitable contributions, they usually think about donating cash or putting it on their credit card. You can, however, donate capital assets, such as stock, which in some cases may be a better move. When you donate capital assets to a charity, you don’t have to pay tax on any of the gain, plus, you get to take a charitable deduction for the full value of your investment (subject to the overall charitable contribution limits). For example, let’s say you bought ABC stock for $10,000 in 1990 and now it’s worth $110,000. If you donate that stock to charity, you’ll avoid the $15,000 ($100,000 gain x 15%) capital gains tax you would have owed had you sold the stock, plus you’ll get a $110,000 charitable contribution deduction (subject to the overall limits). The cherry on top is that for the charity, the $110,000 in stock is an equivalent donation to $110,000 since qualified charities don’t pay any income tax, including the capital gains tax on appreciated investments.

A Final Word
If you’re not one of these people, you should probably check with your tax or financial professional to see if there are other factors that may make this strategy favorable or not. Remember though, in order to lock in today’s low rates, you’ve got to sell by December 31st, so don’t wait too long, or this opportunity might pass you by.

Article Highlights:

• Currently, the maximum rate you will pay on the sale of most long-term capital gain property is 15% of the gain. Next year, that’s scheduled to jump to 20% (a 33% hike)
• Use non-investment money, such as money in a savings or money market account, to pay the tax
• Selling capital gain property is not for everyone, like if you are expecting to be in a lower tax bracket in the future, if you are terminally ill, if you are never going to sell or if you are going to give it to charity

-By Jeff Levine and Jared Trexler

Read More

10 Ways You Might Pay More Tax in 2013

The debates are over and we are now less than two weeks from the election! There's a lot riding on this election for both nominees and both parties, but more importantly, for the American public as a whole. While there are numerous issues that will no doubt require the next President's attention, along with that of our lawmakers, few issues are likely to generate more interest from the American people than the subject of taxes.

For some time now, we've had it pretty good, at least from a tax perspective. That's all about to change though. There are an abundance of changes to the tax law scheduled to take effect in 2013 and they are almost universally going to take a bigger chunk of your money and hand it over to Uncle Sam. Old or young, rich or poor, it really won't matter. If nothing changes between now and the end of the year, you're likely to pay more in taxes next year than you are this year. While ordinary income tax rates get much of the press, there are a lot more ways your tax bill might rise. With that in mind, let's take a look at 10 ways you could very well pay more tax in 2013 than you will in 2012.

Ordinary Income Tax Rates
The Bush era tax cuts that were extended in 2010 are set to expire at the end of this year. If that happens and Congress takes no action, rates for most taxpayers, on both ends of the income spectrum, would increase. For instance, right now those who pay tax at the lowest rate pay just 10% in federal income tax. That number would jump to 15% next year. Similarly, the very highest income tax rate one can pay in 2012 is 35%. The highest rate in 2013, if nothing changes, will be 39.6%.

Sources of income that are subject to ordinary income tax rates include your salary, self-employment income, alimony, interest, short-term capital gains and the portion of your Social Security included in gross income.

Capital Gains
If you hold a capital asset for longer than one year, you get a special tax break on any profit when you sell it. Instead of having the profits subject to ordinary income tax rates, you get to pay tax at long-term capital gains rates, which are more favorable. Like the ordinary rate increases we’re set to see in 2013, the changes in the long-term capital gains rates will impact you, no matter what end of the income spectrum you happen to be on. Currently, if your marginal ordinary rate (the highest ordinary income tax rate you pay tax at) is 10% or 15%, you don’t pay any tax on long-term capital gains. If nothing changes, that nice 0% rate (sure can’t beat that) will become up to 10% next year. At the other end of the spectrum, the maximum long-term capital gains rate is 15% (a savings of almost 60% when compared to the top ordinary rate of 35%). Barring Congressional action between now and next year, the top long-term capital gains rate will be 20%.

Long-term capital gains rates apply to the profits on capital assets held longer than one year. Capital assets include stocks, bonds and real estate, including any portion of your primary residence that is not excluded from income.

Qualified Dividends
The economy generally runs better when people are investing their money in businesses and not just leaving it in the bank. In an effort to encourage more people to invest in businesses, Congress created a special tax break for “qualified dividends,” which are simply dividends that have met certain criteria outlined in the Tax Code. Once again, if nothing changes, taxpayers of all income levels will be hit harder in 2013. The current tax rates for qualified dividends are the same as long-term capital gains rates. If you are in the 10% or 15% marginal ordinary income tax bracket you pay a 0% tax rate on qualified dividends. If you are in one of the higher brackets, you pay a 15% rate.

The rate on qualified dividends isn’t simply scheduled to increase next year. Oh no… it’s much worse. Qualified dividends, as things stand now, won’t even exist next year. Instead of getting a tax break, dividends will be taxed at ordinary income tax rates at whatever marginal bracket you happen to be in, just like your interest is now.

FICA
In 2011 Congress passed what was widely referred to as the “payroll tax holiday.” In essence, it was a one year reduction, from 6.2% to 4.2%, in the amount of FICA (Social Security) taxes taken out of a worker’s paycheck. Self-employed persons received a similar break. The tax break was popular enough that is was later extended through the end of 2012. To this point, Congress has taken no action to further extend this deadline, so workers can expect to see more money taken out of their checks for FICA beginning January 1st.

Once again, taxpayers at all ends of the spectrum will feel the pinch. The 6.2% FICA rate scheduled to be in effect for 2013 is a flat rate, meaning those who earn $10,000 salaries will pay the same 6.2% rate that those making $100,000 will. Those with substantial earned income will not only see their FICA tax rate increase, but more of their income will be subject to the tax. In 2012, only the first $110,100 of earned income was subject to the tax. In 2013, up to $113,700 of earned income will be subject to the tax. As a result, those with high income could pay nearly $2,500 more in FICA tax next year.

The FICA tax is assessed on earned income, both from wages and self-employment. You cannot reduce your FICA tax with deductions on your return.

3.8% Health care Surtax
As if it’s not bad enough that nearly all the rates on various types of personal income are set to increase next year, we’re going to add a brand new tax to the mix as well. If you are a high-income taxpayer, beginning in 2013, you may be hit with an additional 3.8% surtax on all or a portion of your “net investment income.” This 3.8% surtax only applies if your net investment income is above your applicable threshold. If you are married and file a joint return, the threshold is $250,000. If you are single, the threshold is $200,000.

The 3.8% surtax will be assessed on the lesser of the amount of income you are over your applicable threshold or your total sum of investment income. Investment income includes capital gains, interest, dividends, taxable distributions from non-qualified (not retirement account) annuities and rental income (unless that is your business). Earned income, as well as IRA and other retirement account distributions, are not net investment income, but could increase your total income, causing other net investment income to become subject to the surtax.

0.9% Medicare Surtax
Is all your income earned income? If so, you don’t have to worry about the 3.8% surtax on net investment income, but that doesn’t mean you’re out of the woods either. Beginning in 2013 certain higher earners will be hit with an additional 0.9% Medicare Tax (we wrote a Tuesday article about this tax). The thresholds for the new Medicare surtax are the same as the thresholds for the 3.8% healthcare surtax, except here, the only income considered is earned income. Married couples who file a joint return and have combined earned income above $250,000 will be hit with the 0.9% surtax on any excess above that amount. If you are a single filer, you’ll be affected in a similar manner, but on earned income exceeding $200,000.

Earned income includes both wages (salary from an employer) and self-employment income.

Return of Exemption Phase-outs
The loss of personal exemptions is yet another way your tax bill might be a higher in 2013. Under the current law, there is no limit to the amount of income you can have in order to claim personal exemptions. To put it another way, in 2012, even Bill Gates and Warren Buffet can claim personal exemptions. Unless Congress takes action to extend this benefit, the same will not be true next year. Married couples filing a joint return will begin to see their personal exemptions phased out at around $260,000. Single filers will start to see their exemptions phased out at about $175,000 of income (although the President’s budget calls for that number to be closer to $210,000).

In general, you are allowed a personal exemption for yourself and, if you are married and file a joint return, one for your spouse as well. If you claim any dependents, such as a children, you can generally claim an exemption for them as well. An exemption for the same person cannot be claimed on multiple tax returns.

Estate Tax
I hope you’re sitting down for this one. If nothing changes between now and next year things in the estate tax area are about to get bad… real, real bad. Beginning in 2013, there will be three major changes to the estate tax law, and all of them could cause you to pay more taxes. A lot more. The first major change to the estate tax is that the exemption amount is scheduled to drop from the current $5,120,000 all the way back down to $1,000,000. In other words, right now, as long as the total value of your taxable estate is less than $5,120,000 you will owe no federal estate tax, but next year, if your taxable estate value exceeds just $1,000,000 your estate will be subject to federal estate tax.

The second big change to the estate tax law beginning in 2013 is that the rate, itself, is scheduled to increase. As noted above, right now the first $5.12 million you leave to someone other than your spouse can generally pass completely estate tax free. However, if you happen to have an estate with a total value in excess of that amount and you pass away in 2012, any excess would only be hit with a maximum estate tax rate of 35%. In contrast, for deaths occurring on or after January 1, 2013, the maximum estate tax rate is set to increase to 55%! Yep, that’s right. A whole lot more of your estate could be hit with a tax that’s a whole lot higher.

The final big change to the estate tax law that’s scheduled to take place in 2013 and could cause you to pay a lot more in tax is the loss of “portability.” In essence, portability is simply a way to transfer any exemption you have remaining after your death to a surviving spouse without the need for any sophisticated estate planning. If you are married, this can effectively double the amount of assets you can pass estate tax free to children, grandchildren, etc. to $10.24 million. At that number, very few estates should be hit with estate tax. In the past, preserving one’s exemption for a surviving spouse was impossible and the only way to make use of the exemption at the time of the first spouse’s death was to give assets immediately to someone other than the surviving spouse or to use of a special type of trust, known as a credit shelter, or A-B trust. For those passing away in 2013 or later with estates in excess of $1 million, credit shelter trusts may once again become a critical planning vehicle.

The only good news in this area is that it seems like both Republicans and Democrats agree that the estate tax laws for 2013, as scheduled now, seem a little harsh. Though they disagree on the extent of the relief they want, the fact that there is common ground might be cause for optimism that at least some facet of the estate tax law (e.g. the rate or exemption) will be made more palatable.

Gift Tax
The current lifetime gift tax exemption is $5.12, just like the estate tax exemption. The two exemptions are actually unified, meaning that any amount you give away during life that eats into your lifetime gift tax exemption will reduce the amount you can transfer after death estate tax free. For instance, if you gifted $2 million to a child last year and pass away before the end of this year, you can still pass $3.12 million ($5.12 current exemption - $2 million gifted in life). Like the estate tax exemption, the gift tax exemption is scheduled to drop to $1 million. Therefore, if you have a large estate, making a large gift before the end of 2012 should be a topic of conversation between you and your tax and/or financial advisor.

Note: In 2012 you can gift $13,000 per person before using any of your lifetime exemption. In 2014 that amount is increasing to $14,000.

The gift tax issues for 2013 also mirror the estate tax issues in other ways. For instance, like the estate tax, the gift tax rate is scheduled to increase from the current maximum of 35% to 55%. The gift tax exemption is also portable in 2012, a feature that is set to be eliminated beginning in 2013.

GST Tax
The Generation Skipping Transfer, or GST, tax is one of the taxes you pretty much want to do anything possible to avoid (I said avoid, not evade! I know this seems bleak, but don’t go getting any funny ideas on me now.) The GST tax is an additional tax on top of either estate or gift tax, when you transfer property down more than one generation. Most commonly, this comes into play when you are gifting (during life) or bequeathing (after death) your assets to a grandchild or great grandchild, although gifts to non-relatives 37 ½ years or more younger than you would also be hit with the tax.

Under the current law, the GST exemption is $5.12 million. Sound familiar? That means you can give/leave up to $5.12 million to a grandchild completely transfer (gift/estate and GST) tax free. That opens the door for some serious legacy and multi-generation planning opportunities. Those opportunities are not going to stick around forever though. As it stands now, the GST exemption is scheduled to go back down to $1 million in 2013.

Note: Unlike the estate and gift tax exemptions, the GST tax exemption is not portable.
The current GST tax rate is also a “favorable” 35%. Beginning in 2013, that rate, like the estate and gift tax rates, is scheduled to go back up to 55%. That 55%, if nothing changes, could be imposed along with a 55% estate or gift tax. It’s also worth remembering that transfer (estate, gift and GST) taxes are imposed not on the recipient(s) of the assets, but rather, on the donor.

- By Jeff Levine and Jared Trexler

Read More