Tax-planning moves to consider now before federal rates rise in 2013

Posted: July 04, 2012

Absent some miracle before the end of this year, taxes are going up in 2013.

If Congress does not act, federal income taxes on short- and long-term capital gains in our portfolios are scheduled to increase, from 35 percent to 39.6 percent and from 15 percent to 20 percent, respectively. So are taxes on dividends, scheduled to increase from 15 percent in 2012 to 39.6 percent in 2013, or even higher if you are filing in top tax brackets.

The new rates apply to net investment income for single filers earning more than $200,000 and married couples filing jointly earning more than $250,000.

And now that the Supreme Court ruled that the Affordable Care Act of 2010 is constitutional — on tax grounds, rather than the more expansive Commerce Clause — an additional Medicare tax of 3.8 percent will be imposed on what's called "unearned income."

Unearned income means many things (ask your accountant), but it includes such things as investment interest, dividends, capital gains, annuities, royalties, rents, and pass-through income from a passive business and partnerships.

There are some tax-planning moves you can make now to pay a lower tax rate this year and create losses for next year in your portfolio — thus lowering your overall tax bill.

First, consider booking winners in your portfolio in 2012.

In taxable brokerage firm accounts, you could reduce your tax bill by selling appreciated securities this year — instead of waiting to sell them next year and pay a higher tax. "The maximum federal income tax rate on long-term capital gains from 2012 sales is only 15 percent. Now may be a good time to cash in some long-term winners to benefit from today's historically low capital-gains tax rates," advises Martin Abo, of Abo & Co. L.L.C., certified public accountants and litigation/forensic consultants.

Second, bite the bullet and sell some loser securities (currently worth less than you paid for them) before year-end.

The resulting capital losses will offset capital gains from other sales this year, including short-term gains from securities owned for one year or less that would otherwise be taxed at ordinary income tax rates.

If losses for this year exceed gains, you will have a net capital loss for 2012. You can use that net capital loss to shelter up to $3,000 of this year's high-taxed ordinary income from salaries, bonuses, self-employment, and so forth ($1,500 if you're married and file separately). Any excess net capital loss, Abo says, is carried forward to next year.

Third, reevaluate your investment mix.

Preparing for potentially higher taxes on dividends could include investing a larger portion of your income-producing portfolios in tax-exempt municipal bonds instead of dividend-producing stocks, or buying dividend-producing stocks in tax-advantaged retirement accounts.

Fourth, convert to a Roth IRA.

Converting to a Roth IRA can be a good strategy if you expect your tax rate to be higher in future years. Qualified distributions from a Roth — including the earnings portion — are tax-free, according to the Fidelity brokerage firm.

The downside to converting is that you have to pay tax on the amount of pretax contributions and earnings you convert. But, again, if you make the conversion in 2012, you'll owe tax at your current rate, not potentially higher future rates.

But what if tax rates don't go up? You can undo a Roth IRA conversion until Oct. 15 of the year following the conversion year. So if you convert this year (2012) and Congress decides to retain the current tax rates — or even to lower them — you can change your mind by Oct. 15, 2013.

Estate and gift taxes also were part of the Bush-era 2001 tax cuts that were extended until 2013. For 2012, beneficiaries have to pay estate tax on amounts of more than $5.12 million at a top rate of 35 percent. The exemption is scheduled to revert to $1 million in 2013, and the top rate will increase to 55 percent.

Erin Arvedlund is a finance reporter in Philadelphia. Contact her at 646-797-0759 or erinarvedlund@yahoo.com. Read more of her columns at www.philly.com/arvedlund.

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