| 30 November 2011
The Super Committee's inaction two weeks ago will lead to interesting tax planning for the next several years. Every year at this time I write about year-end tax planning ideas with the hope that future tax issues will bring you more wealth. But with the apparent gridlock in Congress this year, I am starting to get the feeling that the Bush tax cuts that are set to expire next year might just expire. That would make 2013 a higher tax year for a lot of people. With that in mind, consider talking to your accountant before December 31 (since I cannot give tax advice) about the following opportunities.
First, the law allowing charitable gifting from your IRA to avoid required minimum distributions (RMDs) expires December 31, 2011. Under this law, anyone over 70½ can give up to $100,000 from an IRA directly to a qualifying charity and not have it count as taxable income. There are a lot of rules around this, so make sure you discuss how to do it with your advisor. In general, however, this is a great way to help out others with money you might not want to be taxed on this year. At this time, there is not an extension in the works for 2012.
Second, mutual funds must distribute income and internal capital gains each year. Many funds make these distributions by the first week of December, so time is of the essence. If the funds you hold pay out taxable distributions, compare the associated taxes you will pay to what you might pay if you sold your investment in the funds themselves prior to distribution (the ex-dividend date). With the recent market volatility, you might be able to sell your fund with little taxable gain, if any. Some might even qualify for a 0% capital gains rate in 2011, so it might make sense for you to sell enough to fill up that tax bracket. If you do this, remember that if the Bush tax cuts expire, rates will move up on top of the new 3.8% Medicare tax that starts in 2013, and that the new Medicare tax could be triggered by capital gains/distributions. Thus, as you reposition these assets, consider lower-turnover mutual funds (index funds work for this) in order to limit this ongoing problem.
Third, Roth IRA conversions have become popular since income limitations are no longer part of the law. Thus, anyone can convert an IRA to a Roth IRA. Conversions can be beneficial for people in lower tax brackets within the current year who also expect their future tax brackets to be higher. This could include business owners with negative income this year, a new retiree in a low bracket, or even someone with a blip in their income this year due to unemployment or taking time off to help a sick parent. Make sure you ask your advisor about the aggregation rules, since you do not want to get tripped up on those and incur penalties.
Fourth, gifting to heirs changed this year with a new $5 million federal gift tax exclusion. (Minnesota is still at $1 million so you would owe taxes over that amount.) This exclusion may have changed had the Super Committee agreed on new cuts/taxes, but since they did not there is still time to move assets out of your estate that might appreciate in the future. This law is set to expire at the end of 2012.
These are four of my favorite year-end tax planning tips every year because they can add a lot of value to any portfolio's bottom line. Keep in mind that your portfolio's return is after fees and taxes; so paying less in taxes helps that number. The general inactivity of Congress leaves a big question mark about the potential sun-setting of the Bush tax cuts, an issue that will only make the ideas above that much more powerful.
