America is on the verge of the largest tax increase in 19 years – an event commonly referred to as Taxmageddon by television news programs and print publications. What is causing this nightmare? Primarily, the expiration of the Bush tax cuts and the presidential election. While you may not be concerned with the politics of Washington, the one thing you are undoubtedly concerned about is the impact those rumblings will have on your wallet. So, how do politics combine with taxes to make the perfect storm?
Americans will pay approximately $4.041 trillion in 2012 taxes alone. Currently, there are more than 1,000 pending pieces of legislation around tax policy on Capital Hill. This current gridlock in Washington plus the increasing federal deficit leads many analysts to believe that higher taxes are on the horizon. Furthermore, if Congress does not pass new legislation, broader tax increases are inevitable for most Americans.
If Congress does not take action before December 31, 2012, all the marginal tax rates are scheduled to increase. With that in mind, it may make sense to bring all income into the 2012 year wherever possible and take deductions in 2013. Another way to pay tax on income in 2012 would be to do a ROTH Conversion. Currently, Roth IRAs represent a savings vehicle with minimal restrictions and the ability to accumulate income tax fee . If tax rates do increase as scheduled in 2013, taxpayers who convert Traditional IRAs to Roth IRAs will be subject to higher taxes on the converted IRA.
Capital gains rates (for long-term capital gains) are scheduled to rise from 15% to 20%. When you have a capital gain, normally the first thing you think about is whether you should sell an investment or two that are at a loss to offset your gains. The question now is –, would that loss be worth more later?
The current tax-favored status of dividends is scheduled to expire. Qualified dividend rates are scheduled to rise from 15% to ordinary income tax rates. In other words, dividends would increase from 15% to a taxpayer’s marginal tax rate. That could be as high as 39.6%.
If the Alternative Minimum Tax (AMT) “patches” are allowed to expire, many middle- income Americans may be subject to a 28% AMT tax rate. What is AMT? This additional tax review is in place to ensure high-income households pay their due portion of taxes. As part of its review, AMT used a different set of calculations, which do not factor in many deductions and exemptions. The AMT income-exemption amounts have increased incrementally each year in line with inflation, but these allowances are scheduled to phase out this year. Without these annual “patches,” AMT exemptions could return to the year 2000 levels, thus imposing the AMT on a significant number of middle-income taxpayers for whom it was never intended. “Four million taxpayers paid AMT in 2011, and more that 31 million are expected to see their liabilities rise in 2012.
The impact of increased taxes doesn’t end with the potential expiration of the Bush tax cuts. It also carries over from new legislation surrounding health care reform. Beginning in January, the employee portion of the Medicare payroll tax will be 1.45% for the first $250,000 ($200,000 if single) and an additional 2.35% for income over $250,000 ($200,000 if single). For example, a couple making $300,000 per year would have their first $250,000 taxed at 1.45%, and $50,000 would be additional taxed at 2.35%. It is important to note that employer Medicare taxes will not see the same increase – remaining at 1.45% regardless of income.
Beginning in 2013, you may find yourself paying a 3.8% investment excise tax. New investment income is defined as interest, dividend, and distributions from non-qualified annuities, royalties and rental income. Net investment income does not include distributions from qualified plans as well as municipal bond interest. The excise tax will be charged to the lesser of net investment income or MAGI over the $250,000 threshold ($200,000 if single). For example, if you are a married couple with a $275,000 modified adjusted gross income and have $20,000 in qualified dividends, currently you would pay $20,000 x .15 = $3,000 in taxes. In 2013, it could be $20,000 x (36% + 3.8%) = $7,960.
It is impossible to assess how the tax code will change; however, being proactive now may be the best way to help minimize the potential impact you will feel.
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