As Congress continues to debate taxes, the rest of us stand by in anticipation.
Of the three possible tax scenarios, which include extending President Bush’s tax cuts, letting the cuts expire all together or enacting President Obama’s tax plan, it is likely that most of us will see some tax increases, whether it be in the form of income, investments and/or estate taxes.
With these looming tax changes comes the increased urgency for year-end tax planning and preparation for 2011 and beyond. Not knowing what the new tax legislation will have in store can create some confusion when planning ahead.
Consider the following strategies for reducing your estate, income and investment taxes today and lessoning your tax liabilities tomorrow.
As of Jan. 1, the estate tax repeal will expire and return it to its pre-Bush tax rate of 55 percent on any value more than the $1 million exemption.
It has been widely speculated that President Obama would favor the 2009 rates of 45 percent with a $3.5 million exemption for 2011. However, in his most recent proposal he suggested a 35 percent tax with a $5 million exemption as a temporary solution.
Regardless of the outcome, estate taxes only have one direction to go from the record low level of zero this year, which is up.
While it is heirs who pay estate taxes, to assist with reducing the future tax liability today consider a Roth conversion. You can convert all or a portion of your traditional retirement savings plan, such as a 401(k) or IRA, whether or not you are currently working or in retirement. Since you pay taxes at the time of conversion, the total account value would be reduced, reducing the total size of your estate.
However, it is important to note that the converted amount is considered income and is taxed as such. While there are special provisions this year that allow for taxes to be paid over the next two years, with the last payment due in 2010, paying the lump sum this year will ensure you lock in this year’s tax rates.
Currently, income tax brackets start at 10 percent for the lowest income earners and climb to 35 percent for the highest income earners.
Prior to the Bush tax cuts, there were only five tax brackets as opposed to six, the lowest bracket at 15 percent and the highest at 39.6 percent. If lawmakers make no change, tax rates would revert to these rates as of January 1.
Under Obama’s proposed plan, the highest income bracket would rise from 35 percent to 39.6 percent, and the second-highest would rise from 33 percent to 36 percent. Other income tax rates would remain at current levels. However, the brackets would change.
To decrease your countable income, consider increasing your pretax retirement contributions.
For 2010, 401(k) contribution limits are $16,500 and IRA limits are $5,000. If you are 50 years or older, you can catch up by adding an additional $5,500 to your 401(k) and $1,000 to your IRA. Next year’s contribution limits are scheduled to remain the same.
Additionally, consider increasing your pretax health savings account contributions. In 2010, contribution limits will remain at $3,050 for employee-only coverage and $6,150 for family coverage. Next year’s contribution limits are scheduled to remain the same as well.
Currently, taxes on short-term capital gains are taxed at ordinary income tax rates ranging from 10 percent to 35 percent. Long-term capital gains are tax-free for those in the two lowest income brackets and taxed at 15 percent for the remaining four. These tax cuts are scheduled to expire end of year as well.
Prior to Bush tax cuts, taxes on short-term capital gains were taxed at ordinary income tax rates ranging from 15 percent to 39.6 percent. For long-term capital gains, the two lowest income brackets were taxed at 10 percent and the remaining tax brackets were taxed at 20 percent.
Under Obama’s proposed plan, short-term capital gains would be taxed as ordinary income and long-term capital gains would continue the 15 percent tax rate for the 25 percent and 28 percent income tax brackets and increase the tax rate to 20 percent for higher income brackets.
To reduce your investment taxes, consider cashing in your cash cows. Those investments that have significantly increased in value over the years can be cashed in before end of year to lock in today’s tax rates on the gains. While you can repurchase the investment in the future, any prior gains have already been realized and taxed at today’s rates.
Bryan Philpott is a registered financial consultant and Todd Witt is a financial adviser, both for Aspire Wealth Management, a financial-advisory firm headquartered in Cornelius.