Larry D. Spears writes: It's often said the only things certain in life are death and taxes - but this year, even taxes aren't a certainty.
At least not the specifics, thanks to Election 2012 and Taxmageddon 2013. Investors are left with more questions than answers.
Will the so-called Bush tax cuts expire as scheduled - or be extended? Will levies designed to help implement and pay for Obamacare go into effect - or will Republicans finally succeed in repealing the new healthcare program?
Will President Barack Obama view his re-election as a mandate to impose more new taxes to expand social programs, or will a newly-elected President Mitt Romney cut taxes in a bid to encourage renewed economic growth?
That's why it's important for investors to look at the range of possibilities relative to their current financial holdings and take precautionary actions where appropriate.
This special Money Morning series will examine a number of upcoming or proposed changes in tax laws and rates and suggest strategies to minimize their impact on your investments. Or better yet, take advantage of them if possible.
With Taxmageddon, Rates are Set to Rise
As it stands, there are more than two dozen tax-law changes scheduled to take effect in 2013. Some of them target nearly every single taxpayer while others are more narrowly focused on individuals, such as small business stockholders and home sellers.
Of most immediate concern to investors is the scheduled increase in tax rates on capital gains. Currently, the federal government recognizes three types of capital gains:
•Short-term gains - Profits from assets held for less than one full year. These gains are taxed as ordinary income at a rate based on your total personal income, with percentages now ranging from 10% to 35%.
•Ordinary long-term gains - Profits from assets held for more than one year, now taxed at a maximum rate of 15%, regardless of income from other sources. (Note: Individual taxpayers in the 10% and 15% brackets now pay no tax on long-term capital gains but merely include them with other taxable income. However, in 2013 these taxpayers will be subject to a 10% tax on long-term gains.)
•Qualified long-term gains - Profits from assets purchased after the 2000 tax year and held for a minimum of five years. Qualified gains are currently taxed at a maximum 15% rate.
This relatively simple structure will become more complicated in 2013, for several reasons... For starters, there is no scheduled increase in tax rates for short-term capital gains - they'll still be taxed at ordinary income rates. However, if Congress allows the Bush-era tax cuts to expire, those ordinary rates will rise substantially.
For example, those in the lowest income-tax bracket - individuals earning less than $8,700 or married couples earning less than $17,400 - will see their tax rate jump from 10% to 15%, with the increase applying to short-term gains as well. (Note: The income levels cited for various tax brackets are for 2012; they'll be adjusted for inflation in 2013.)
Taxpayers in the next bracket - individuals earning from $8,700 to $35,350 and couples earning from $17,400 to $70,700 - will see no increase in their current 15% marginal tax rate. But there is one catch! Rather than being double that for unmarried taxpayers, the income level at the top of the bracket for married couples will be reduced to 167% of the individual cap - just $59,035 based on 2012 numbers.
This will put substantially more joint tax filers in the new 28% bracket (now 25%), increasing the so-called "marriage penalty" and effectively almost doubling their rate on short-term capital gains as well.
Taxpayers in the current 25%, 28% and 33% brackets will see their marginal tax rates jump by 3% in 2013, while those in the highest bracket - individuals and couples earning more than $388,350 - will see a 4.6% increase from 35% to 39.6%.
Individuals in the highest brackets could also see an additional 3.8% bump in their capital gains rates if Obamacare - formally, the Patient Protection and Affordable Care Act (PPACA) - is not repealed and the included "Medicare contribution tax" is assessed on unearned income.
How to Minimize the Taxman's Bite
Given those changes, the best strategy if you have short-term gains and want to take them for other-than-tax reasons - e.g., technical resistance or fading fundamentals on a stock - is to take them before the end of the year, when your ordinary income rates will still be lower.
On the other hand, if you're in a higher bracket, currently have short-term gains and have no other reason to sell, don't. You'll be better off to hold into 2013, let the gains go long-term and then sell, paying the 20% maximum that will be imposed then.
The optimum strategy if you already have long-term gains is the exact opposite.
As noted, the current rate on both ordinary and qualified long-term gains is 15%. However, beginning Jan. 1, 2013, that rate will climb to 20% for ordinary long-term gains and 18% for qualified (or five-year) gains. (Note: Individual taxpayers in the 10% and 15% brackets now pay no tax on long-term capital gains but merely include them with other taxable income. However, in 2013 these taxpayers will be subject to a 10% tax on long-term gains.)
Plus, if you're in one of the upper income brackets, your gains will also be subject to the 3.8% Medicare contribution tax, which would raise your 2013 rates on ordinary and qualified long-term gains to 23.8% and 21.8%, respectively.
Given that, all investors holding positions with long-term gains, qualified or not, should keep a close eye on both the election results and the actions of Congress in the wake of the vote. If mid-December rolls around and lawmakers haven't taken action to either extend the Bush tax rates or repeal the Obamacare tax, your best strategy will be to sell your appreciated assets before year-end so you'll only owe 2012's lower 15% capital gains rate.
(Note: This strategy is doubly important for investors in states with capital-gains or income-tax rates assessed as a percentage of federal rates.)
If you still like the long-term prospects for your stock or other security, you can simply wait until after Jan. 31, 2013 and buy it back, starting a new holding period - and perhaps getting a better price if other investors are also selling their shares. (Technically, you only have to wait more than 30 days before rebuying to avoid the so-called "wash sale" rule, but why squeeze the deadline and tempt the IRS.)
One other strategy note: If you have losing long-term securities positions, you may also want to sell those holdings before the end of the year. You can use the losses to offset gains on the profits you take this year, plus you can carry any excess losses forward and apply them against gains you may have in 2013. Given the higher rates then, that will increase the tax value of your current capital losses.
In the next installment of our tax series, we'll discuss changes in the 2013 rules and rates for dividends on stocks and exchange-traded fund (ETF) - an area of major concern for income-oriented investors.
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