Savvy taxpayers know they need to make some tax moves before each new year to lower their tax bills when they file their returns next year.
In 2012, however, those tax tasks are complicated by the possibility that tax laws will change dramatically if Congress and President Barack Obama don't reach some agreement by year's end.
"What's certain is rates today," says Gregory A. Rosica, tax partner with Ernst & Young in the firm's Tampa, Fla., office. "What's tentatively certain is rates are changing on Jan. 1."
On that date, scheduled changes include higher personal income tax rates, reduced itemized deductions for high-income taxpayers and increased taxes on capital gains and dividend earnings, to name a few.
Tax move No. 1: Increase your income
If the President George W. Bush-era tax cuts do expire as scheduled Jan. 1, 2013, income tax rates will go up across the board. The lowest tax rate will be 15 percent instead of 10 percent, and the top tax rate will go from 35 percent to 39.6 percent. The rates between those two extremes also will creep up a bit.
Rosica suggests taxpayers can have two year-end tax strategies: one for the current tax situation and the other in case the changes do take effect next year. "Develop a plan, and then pause and wait to see what transpires," he says.
If it looks like tax rates will be higher in 2013, accelerate income into 2012 to take advantage of the current lower rates.
Moving income into 2012 also could help eliminate or ease the new 0.9 percent Medicare tax that takes effect next year. This added payroll tax is part of the Affordable Care Act, or Obamacare, and applies to total wages (and self-employment income) that exceed $200,000 for individuals and $250,000 for couples filing a joint return.
Tax move No. 2: Take capital gains
The capital gains rate is 15 percent for most taxpayers and zero percent for taxpayers in the current 10 percent and 15 percent tax brackets. On Jan. 1, 2013, those rates are scheduled to increase to 20 percent and 10 percent, respectively.
By taking gains in 2012, taxpayers will avoid the potentially higher tax rates.
Those with higher incomes also will avoid another health care-related Medicare tax that takes effect next year. An additional 3.8 percent Medicare tax on net investment income will apply to single filers making more than $200,000 and married joint filers with combined incomes of more than $250,000.
These higher-income taxpayers could see the capital gains tax go from the existing 15 percent to 23.8 percent in 2013.
Investors also might want to look into reallocating their portfolios so that they don't own as many dividend-paying stocks. Right now, the tax on qualified dividends is the same as capital gains, 15 percent. On Jan. 1, 2013, dividends could be taxed at ordinary income tax rates.
So, a top investment earner next year could face a 43.4 percent tax on dividends: 39.6 percent maximum income tax rate plus the 3.8 percent health care surtax.
Tax move No. 3: Harvest investment losses
One easy way to reduce capital gains taxes regardless of rate is to sell assets that have lost value and then use those losses to offset gains.
But if the capital gains tax rate goes up in 2013, you might want to hold off on selling those losers this year. You can use them to reduce next year's higher-taxed gains.
"If this year's losses are less than the gains they would be offsetting, it might be wiser to hold them for an increasing tax rate environment," says Rosica.
Losses in excess of your gains also are useful at tax time.
Up to $3,000 a year in excess of losses can be used to reduce ordinary income. If you have more than that, you can use the loss amounts in future tax years. That could be helpful next year if capital gains and income tax rates go up as scheduled.
Tax move No. 4: Get medical, dental work done
Another health care act tax provision will make it more difficult to claim itemized medical deductions.
For 2012 taxes, medical deductions must exceed 7.5 percent of adjusted gross income before they can be claimed. In 2013, the expenses must be more than 10 percent of AGI.
"If there is a chance of exceeding the 7.5 percent floor this year, the individual may want to accelerate into this year discretionary medical expenses, such as prescription glasses and sunglasses, and elective medical or dental procedures not covered by insurance," says Robin Christian, CPA and senior tax analyst for Thomson Reuters in Fort Worth, Texas.
Tax move No. 5: Defer deductions
For some taxpayers, taking advantage of 2012's lower threshold for itemized medical deductions is a good year-end tax strategy.
Other taxpayers, however, might want to claim the standard deduction this year and defer itemized expenses until next year, when they can offset possible higher tax rates.
Another deferral decision is when to pay your last mortgage bill of the year. You can decide to not pay your January mortgage in December, or put off paying your property taxes until the 2013 due date. And make your usual year-end charitable contributions in early January.
Be careful, though, if you expect to make a lot of money in 2013. You could lose some of your deductions. The law that reduces by 3 percent the total of Schedule A claims for high-income earners is one of the former tax laws set to return next year.
Tax move No. 6: Convert to a Roth
If you're considering converting a traditional individual retirement account to a Roth IRA, there are two reasons to do so in 2012.
First, you'll avoid the possibly higher 2013 tax rates on the taxable portion of the converted amount.
Second, you won't have to worry about any possible Medicare surtax issues.
"While the surtax does not apply to income from a Roth IRA conversion, the income from a 2013 Roth conversion could push a taxpayer's adjusted gross income above the applicable threshold," says Bob D. Scharin, senior tax analyst for Thomson Reuters in New York City. "If that occurs, the Roth conversion could trigger a surtax on the taxpayer's investment income."
As Scharin notes, Roth earnings are not taxable income when you withdraw them in retirement or after holding them for five years because you paid tax on the money before you put it into the account. But when you convert a traditional IRA on which taxes are deferred to a tax-free Roth, you must pay tax on the amount of pretax contributions and earnings you transfer.
If your traditional IRA earnings are large -- $100,000 is not unusual for an account that's been growing tax-deferred for many years -- the conversion amount combined with your earnings on other taxable assets could push your earnings past the $200,000 threshold for single filers ($250,000 for married couples filing jointly). And that would require you to pay the 3.8 percent Medicare surtax in 2013.
But what happens if you convert and the tax rates don't increase (or your stock holdings suffer losses)? You can nullify the conversion tax by recharacterizing your converted Roth back to a traditional IRA. You have until Oct. 15, 2013, to make that reversal.
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