Tax planning for the fiscal cliff

December 4, 2012 

By now, we've all heard about the "fiscal cliff," a term used to describe the "perfect storm" of expiring tax cuts and new taxes set to take effect in 2013. When combined with government spending cuts required as part of the debt ceiling deal that raised our nation's borrowing limit in 2011, many predict that, if not quickly modified, this "fiscal cliff" could send our economy into another recession.

Since the election, "fiscal cliff" concerns have helped drive the stock market down for several straight days, and a recent American Association of Individual Investors' survey noted investor sentiment is more bearish now than in over a year. But compared to the debt crisis in 2011, the "fiscal cliff" is more likely to extend our sluggish growth in the economy rather than send us into

a downward spiral any time soon.

If all these planned changes take effect, Federal taxes on ordinary income will rise. The top tax bracket rises from 35 percent to 39.6 percent, and the top capital gains rate will rise from 15 percent to 20 percent. Employee payroll taxes will go back to 6.2 percent, and dividends won't enjoy their favored 15 percent tax rate any more: instead, they'll be taxed as ordinary income.

Starting in 2013, estates worth more than $1 million will again be taxed at 55 percent, down from $5.12 million at 35 percent in 2012.

With this in mind, here are a few strategies some investors/taxpayers might want to consider before year-end:

1. Convert to a Roth IRA. While tax rates are still low, investors may want to consider recognizing more income in 2012.

One strategy for doing this is to convert a traditional IRA to a Roth IRA. Taxes on the amount converted are generally due in the year of the conversion. After conversion at the lower tax rates of 2012, investment earnings and distributions from this IRA will never be income taxed again.

Note: since these Bush tax programs are unlikely to be extended, this is your last month to make such a move before the opportunity expires.

2. Sell appreciated assets in 2012 to recognize long-term capital gains at the 15 percent tax rate and avoid the 3.8 percent Medicare surtax beginning in 2013.

This may be especially attractive to individuals who are contemplating a major transaction such as the sale of real estate or business interests.

3. Invest in municipal bonds. Higher tax rates will increase tax equivalent yields on municipal bonds. Additionally, affluent investors may want to consider an investment in municipal bonds since the interest on municipal bonds is not subject to the new Medicare investment income surtax. Interest income may be subject to the Alternative Minimum Tax as the income is federally tax-free, but other state and local taxes may apply.

4. Schedule elective medical procedures in 2012 if they will entail significant out-of-pocket expenses because the ability to deduct these expenses becomes even more difficult in 2013.

These are just a few ideas to consider. Your tax professional/financial planner may have more suggestions specific to your situation to get ready (tax-wise) for 2013. Don't wait! Once Jan. 1 arrives, some of these opportunities will be gone.

Karin Grablin, a certified financial planner with SRQ Wealth Management, 1819 Main St., Sarasota, can be reached at 941-556-9004 or

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