The Investment Tax Landscape: Countdown to 2013

In December 2010, Congress extended the so-called Bush-era tax cuts.  As of January 1, 2013, federal tax rates on income, qualifying dividends, and capital gains (among other provisions) are scheduled to revert to previous levels.

In the chart below, we have attempted to outline the current state of the tax law and the result in January if Congress fails to act.  
 

Given recent partisan wrangling, no one can be completely sure if any or all of these changes will occur. But we want to highlight a few possibilities for you to consider as the end of the year approaches. 

Capital gains

If you're considering selling an asset that has appreciated substantially, consider whether you should do so this year rather than next year. Even if some current income tax rates are extended, individuals or households with incomes above the $200,000/$250,000 limits might still face higher rates.

Consult with your CPA about the alternative minimum tax in your calculations. Although the AMT doesn't apply directly to long-term capital gains and qualifying dividends, they're included when calculating your taxable income under the AMT. If realizing a large capital gain indirectly increases your AMT exposure or might push you into the phaseout range for AMT exemptions, that could potentially wipe out any tax savings from selling this year.

Some people may consider selling positions this year, and re-purchasing the same position next year.  While this may have some merit, we are not counseling clients to do so.  The transaction costs and potential effect on your investment policy is considerable. 

Dividends

As of 2013, qualifying dividends are scheduled to be taxed as ordinary income, as they were before 2003, rather than at the lower rate for long-term capital gains. The higher your tax bracket and the more you rely on dividends for income, the more you should be aware of the potential impact of that change in your tax planning.

Investment income/payroll taxes

Beginning in 2013, a new 3.8% Medicare contribution tax will be imposed on some or all of the unearned income of individuals with high modified adjusted gross incomes (see table). Also, the hospital insurance portion of the payroll tax is scheduled to increase by 0.9% for higher-income individuals. We have been incorporating this tax into our financial projections.