Category Archives: IRA Distributions

2012 year-end tax planning – 2012 vs. 2013 tax strategies requiring action now

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The goal for tax planning, as always, is to minimize the total that you pay for 2012 and 2013. However, this year is tricky. Here is why:
First, if your 2013 income is expected to be over $250,000 ($200,000 for singles), you cannot just accelerate write-offs from 2013 into 2012 and defer income to 2013 because your taxes will be higher in 2013. There is a new 3.8% tax that works like this, for example: recognizing a capital gain in 2012 avoids that tax in 2013 and also reduces your 2013 adjusted gross income, which may keep it below the threshold for imposing that tax next year. (See below for more details on the new tax.)
Second, regardless of who becomes President, Congress is likely to reduce the amount or value of itemized deductions. Thus, you may want to accelerate what you can into 2012.
Third, as always, combine your tax planning with your investment strategies, such as tax loss harvesting and rebalancing (see explanations at the end).
Last, there are other issues to review for 2012, including converting your Roth IRA; gifting to children and grandchildren for estate planning purposes (to use the $5 million unified credit); and funding college for children or grandchildren.
However, if you will owe the alternative minimum tax (AMT), you may have to revise your strategy. Many write-offs must be added back when you calculate the AMT liability, including sales taxes, state income taxes, property taxes, some medical and most miscellaneous deductions. Large gains can also trigger the tax if they cost you some of your AMT exemption.
The best tool for planning is to do a projection for both 2012 and 2013, then see what items you can affect to reduce the total tax for both years.
Assuming you will not have an AMT problem in either year, then in 2012 you could:
• Take a bonus this year to save the 0.9% for a high-income earner;
• Sell investment assets to save the 3.8% tax next year so the gain or income is in 2012 (e.g., sales of appreciated property or business interests, Roth IRA conversions, potential acceleration of bonuses or wages);
• Defer some itemized deductions to 2013 (but, be wary of the possibility that these will be capped in 2013 and can affect your AMT for either year);
• Accelerate income from your business or partnership, depending on whether it is an active or passive business; and
• Convert Roth IRAs in 2012 as noted above.
Then in 2013 and future years, you could:
• Purchase tax-exempt bonds;
• Review your asset allocation to see if you can increase your exposure to growth assets, or add to tax-exempt investments, rather than income producing assets. Also, place equities with high dividends and taxable bonds with high interest rates into retirement accounts;
• Bunch discretionary income into the same year whenever possible so that some years the MAGI stays under the threshold;
• While we do not recommend tax-deferred annuities, they can help save tax now to pay taxes in the future when the payments are withdrawn. (These are not recommended due to high fees, illiquidity and often poor performance);
• Add real estate investments where the income is sheltered by depreciation;
• Convert IRA assets to a Roth. Even though the future distributions from both traditional and Roth IRAs are not treated as net investment income, the Roth will not increase the threshold income; and
• Reduce AGI by “above-the-line” deductions, such as deductible contributions to IRAs and qualified plans, and health savings accounts and the possible return of the teach supplies deduction.
Note, however, Congress has not finalized the 2012 rules. Some expected steps are:
• An increase in the AMT exemption to $78,750 ($50,600 for singles), raising it from 2012 rather than dropping back to 2001 rates;
• Teacher $250 supplies deduction on page 1 of 1040, as mentioned above; and
• IRA $100,000 tax free gifts to charities.
Here are the details on the 2013 tax increases, enacted to help fund health care:
• A new 3.8% Medicare tax on the “net investment income,” including dividends, interest, and capital gains, of individuals with income above the thresholds ($250,000 if married and $200,000 if single);
• 0.9% increase (from 1.45% to 2.35%) in the employee portion of the Hospital Insurance Tax on wages above the same thresholds;
• Increase in the top two ordinary income tax rates (33% to 36% and 35% to 39.6%);
• Increase in the capital gains rate (15% to 20%);
• Increase in the tax rate on qualified dividends (15% to a top marginal rate of 39.6%).
• Reinstatement of personal exemption phase-outs and limits on itemized deductions for high-income taxpayers (effectively increasing tax rates by 1.2%).
• Reinstatement of higher federal estate and gift tax rates and lower exemption amounts.
If these changes take effect, the maximum individual tax rates in 2013 could be as high as follows:
2012 vs. 2013
Wages: 36.45 vs. 43.15%
Capital gains: 15 vs. 20%
Qualified dividends: 15 vs. 46.6%
Other passive income: 35 vs. 46.6%
Estate taxes: 35 vs. 55%
*Includes 1.45% employee portion of existing Hospital Insurance Tax.
**Estate and gift tax exemption also drops from $5.12 million to $1 million, if Congress does not act soon.
Explanations:
Tax-loss harvesting:
>Review your investments to find stocks, mutual funds or bonds that have gone down so that selling now will create a loss. This loss shelters realized gains and up to $3,000 of other income.
N.B. – If you replace the stock, mutual fund or bond, wait 30 days or use similar, but not identical, item. Otherwise, the “wash sale” rules eliminate realization of the loss.
Rebalancing:
>review your asset allocation to see if any portion is over or under-weighted. Then sell and buy to bring the allocation back in line. However, if you sell and re-buy now, before a dividend is declared, you will receive a 1099 for a taxable dividend in the new fund for investment returns in which you did not participate.

Thanks to the Kiplinger’s Tax Newsletter, Sapers & Wallack and others for ideas and information.

Roth Conversions – decisions on 2010, recharacterize now or pay taxes over two years?

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You can still decide as late as October 15th (if you extend filing of your tax returns) to either recharacterize or pay the taxes in 2011 and 2012 instead of on your 2010 taxes for your 2010 conversion to a Roth IRA.

Recharacterize – if you have the misfortune of losing value on the IRA after converting, you can “un-convert” by “recharacterizing” the Roth IRA as a traditional IRA using an IRA-to-IRA transfer (do not distribute funds to yourself, as that distribution voids the recharacterization). You can do this for all or a portion of the account. Once you do so, you cannot convert again until later of 30 days after the recharacterization or the year after the year of the original conversion.
This strategy is useful to address a decreased IRA value or to shift the conversion into future years with less income, so you are in a lower tax bracket.

Tax payments – 2010 is the only year where you can choose to have the income of the conversion split in half and carried onto your 2011 and 2012 tax returns. This (1) spreads the time to come up with funds to pay the taxes (you never want to use the funds in the IRA as that defeats the purpose) and (2) gives you earnings on funds already available to pay the taxes until the payment due date.

Note: if you are paying taxes on the conversion with your 2010 taxes, the amounts are due April 18, 2011, even if you extend to have the option of recharacterizing. If you do recharacterize, then you will have over paid and have a refund due …. until you convert again.

Tax Planning – take the IRA distribution or defer?

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Here is another year-end tax planning issue for people taking the required minimum IRA distributions:

Do you defer as the 2009 law allows or do you take it now because tax rates will be going up?

Input from Kiplingers is reprinted below.

For me the issue is alternate sources of cash flow. If you can defer, even against rising rates, that usually pays off because of the compounding of sheltered growth

However, this depends on how you have invested as well as your cash flow needs so everyone has to review

Thanks,

Steven Contact

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To Tap or Not to Tap Your IRA

You can skip your distribution this year and save on taxes.
By Mary Beth Franklin, Senior Editor, Kiplinger’s Personal Finance
November 25, 2009

If you are at least 70½ years old, you normally must take a taxable distribution from your traditional IRA or employer-provided retirement plan by the end of the year — whether you need the money or not — or face a stiff penalty equal to half of the amount you failed to withdraw. But this year is different. Uncle Sam says you can skip your required minimum distribution for 2009. (Employees who continue working past age 70½ are not subject to mandatory distributions from their company plans until they retire, but they still must take distributions from their IRAs.)

IRA owners who turned 70½ between July 1 and December 31 would normally have to take their first distribution by April 1, 2010. But thanks to the waiver, they can skip that, too, delaying their first mandatory-distribution deadline until December 31, 2010.

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* The New Roth Rollover Rules

And if you tapped your IRA earlier in the year and now regret it, the usual 60-day rollover period, which allows you to redeposit the money tax- and penalty-free, has been extended to November 30. But there’s a catch: You are allowed to put one IRA withdrawal back into the account within 365 days. So if you received regular distributions every month, for example, then you can put only one of the withdrawals back in. If you received the money in a lump sum, however, then you can put it all back (including any taxes withheld from the distribution; otherwise it will be considered a distribution and will be taxed as ordinary income).

The one-year moratorium on mandatory distributions also applies to owners of inherited IRAs and other retirement accounts. For example, if you inherited your mother’s IRA and planned to take annual distributions based on your own life expectancy, you can forgo this year’s withdrawal. Or if you follow another set of distribution rules that require you to empty an inherited IRA by the end of the fifth year after the owner’s death, you now have an additional year to do so.

Although there are no required minimum distributions for Roth IRA owners — regardless of age — nonspouse beneficiaries who inherit a Roth are subject to the mandatory distributions. They can skip this year’s withdrawal, too.

Of course, you can tap your traditional IRA this year if you wish and pay taxes at your ordinary rate on the entire amount you withdraw. But if you don’t need the money, there are several advantages to skipping a distribution for 2009. Keeping your money invested in a tax-deferred IRA will give your account even more to time to recover from the worst market collapse since the Great Depression. Plus, not taking an IRA distribution this year could reduce the tax bill on your other income. You might be able to trim the amount of your Social Security benefits that are taxed, and with a lower income, you may be eligible for other tax breaks that you normally can’t use, such as deducting medical expenses in excess of 7.5% of your adjusted gross income.

You can still opt to send up to $100,000 of your IRA distribution directly to a charity. While you can’t double-dip and deduct the donation as a charitable contribution, the amount will not be added to your taxable income.

Another option: Because you aren’t required to withdraw the money this year, you may want to roll some of it into a Roth IRA. (See more on Roth IRA choices here.) You’ll have to pay taxes when you make the switch, but you can take tax-free withdrawals after five years, you never have to take required minimum distributions, and you can create a tax-free inheritance for your heirs. You don’t need earned income to convert a traditional IRA to a Roth, but to qualify, your income — not counting converted amounts — can’t top $100,000 in 2009.

Tags: Roth IRAs and Roth 401(k)s Making Your Money Last, Saving for Retirement, Tax Breaks, Tax Planning

Let us know if you have questions or comments. Thanks,

Steven