Who could miss all the political discussion regarding extending the “Bush era” tax cuts? The facts are that if those tax cuts are not extended, the country is in for considerably greater income taxes next year, since the top rates, currently at 33 percent and 36 percent, are scheduled to increase to 36 percent and 39.6 percent, respectively. Top earners will see their tax rates on qualified dividends go up from the current 15 percent level to 39.6 percent. On top of these, scheduled increases will be added to the investment surtax of 3.8 percent which will offset some of the cost of the Affordable Care Act.
Two other areas that will also see tax increases are long-term capital gains and the federal estate tax.
Now may be the time to sell that stock in your portfolio that is eligible for long-term capital gain treatment, since you may have to pay zero federal income taxes, depending on what your adjusted gross income will be for tax year 2012. Under the Bush tax cuts, which will expire at the end of the year, the capital gains tax rate is 0 percent for taxpayers who are within the 15 percent marginal income tax rate. The bracket tops out at $70,700 for married couples filing jointly, and, if you have dependents and itemize your deductions, your gross income could be well into six figures.
As an example, assume that you and your wife have three children and your salary and bonus this year will be $110,000. Your 401(k) contribution is $10,000 and your mortgage interest, taxes and charitable deductions total $17,000. $125,000 minus 12,500 minus 22,000 minus 19,000 for five personal exemptions equals an adjusted gross income of $64,000. If you sold stock and had a $10,000 capital gain, $6,700 of the tax would be federal income tax free and the excess of $3,300 would be taxed at 15 percent. You would then pay only $495 in federal income tax on the $10,000 gain. This special 0 percent rate also applies to qualified dividends that you receive this year.
Bear in mind that this tax treatment only applies to non-qualified assets (not in an IRA or company-sponsored retirement plan). So, if you have real estate or securities that have been held for at least 12 months and have escalated in value, it may be time to sell this year. What may or may not happen next year is anyone’s guess.
On another tax front, the federal estate tax has been around in one form or another since 1797, according the Joint Committee on Taxation. This year, the personal exemption is $5 million and the tax rate on the excess is 35 percent. The Tax Policy Center projects that only 3,600 estates of persons who die this year will have to pay any estate tax, based on the current exemption level. Without congressional action, the exemption is scheduled to fall back to $1 million in 2013, and the excess would be taxed at a top rate of 55 percent. Additionally, for the very large estates, the changes would call for a 5 percent surtax, as well.
If the exemption level does dip back down to $1 million, the Tax Policy Center estimates that 53,000 estates would have to pay federal estate taxes next year, and upwards of $70 billion of additional revenue would be generated.
Who knows that Congress will do next year? Liberals would love to see the exemption fall to its former level, while most conservatives want the estate tax done away with entirely. Apparently, estate planning attorneys are not confident of congressional action, since Steve Hartnett, associate director of education at the American Academy of Estate Planning Attorneys, stated, “Oh, no. I’m not at all confident we’ll have something certain going forward.”
The betting money is that the levels of 2009 will probably be used going forward, and those were: an exemption amount of $3.5 million and a tax rate of 45 percent. Whatever happens with the estate tax system, it will only be a concern to a small minority of Americans, but it will be a major concern for them.
Got a financial planning question for Greg? You may e-mail him at firstname.lastname@example.org. Greg Roberts is a certified financial planner with 35 years of financial and estate planning experience.