How to Prepare For Rising Tax Rates in 2013
Investors who have done well financially will most likely be looking at double- and even triple-digit increases in their tax rates beginning in 2013.
Regardless of whether President Barack Obama is reelected, the actions he and Congress take in the remainder of 2012 will have an impact on our nation for years to come. That is because they will be dealing with the expiration of the Bush-era tax cuts.
New taxes enacted with President Obama’s Patient Protection and Affordable Care Act (“Obamacare”) are set to take effect in 2013. This means that families with incomes of $250,000 and above will pay an additional 3.8% tax on investment income. At least one analyst predicts the impact of allowing the Bush-era tax cuts to expire, combined with additional taxes imposed by Obamacare, will be a tax rate on dividends rising from 15% to 43.4% – a combined increase of almost 300%.
The top tax rate on capital gains would rise from 15% to 23.8% – an increase of nearly 60% – and the estate tax would rise 55%, as the tax rate rises and the old exemption amount is restored. Additionally, the top rate on ordinary income will rise from 35% to 43.4%, an increase of close to 25%.
How can high-end investors prepare for the very real possibility (some would say inevitability) of rising taxes in 2013 and beyond? For one, you should consider selling assets while the capital gains tax rate is still 15%. One recent study determined that if asset values grow by 4% per year, and the capital gains tax rate increases as scheduled from 15% to 23.8%, an investor would have to hold assets for an additional fifteen years to reach the same level he or she would have been at if he/she had sold the assets initially and paid taxes at the lower rate.
You should also consider receiving ordinary income this year rather than next. As an example, executives could exercise non-qualified stock options this year so that the resulting income is taxed at prevailing rates. On the other hand, the value of deductible expenses, including charitable contributions, will rise in the higher-rate environment and should thus be deferred.
Municipal bonds will become more attractive as the tax-equivalent yield on the same bond – everything else being equal – will be higher in 2013 than in 2012. In a high-tax environment, tax-loss harvesting and buy-and-hold investing both become more attractive. You should also consider life insurance and annuities whose tax-deferral features become more attractive when taxes rise. You can also convert traditional IRAs to Roth IRAs; if you decide to do so, make sure you understand any applicable rules.
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