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Dear ,
Wow This Is Complicated!
To develop an end of year tax plan that is. In most years it isn't that big of a deal. This year it is especially challenging because we don't really know what to plan for. We have the fiscal cliff fast approaching and if recent history is any guide, Congress won't get around to fixing the problem until the last minute.
Nothing sinister going on here. That's just the way negotiations work. As the deadline approaches the sides get a bit more flexible if the desire to reach a deal is great enough. If not then we go over the cliff. I just read an article where Goldman Sachs has said that they believe there is a 55% chance that we get a deal and avoid the fiscal cliff. That's not much better than 50-50. That means that they think there is a 45% chance that we don't get an agreement and we go over the cliff. Folks, that's a significant risk!
GOLDMAN: Stocks Will Tank Another 8% In The Final Weeks Of The Year
(Click to read article)
So What Do We Do?
Here is my take on it folks. We know what we are facing if we go over the cliff. We don't know what we are facing if they reach a deal and we won't know for certain until after the fact. Therefore my suggestion would be to develop a plan that deals with going over the cliff. My guess is that any deal is going to be some sort of modification of going over the cliff and so we should be able to adapt from our cliff scenario. Make sense?
Now just to refresh our memories let's take a look at this chart from PIMCO. I used this one a couple of weeks ago.
Now there are some issues in the fiscal cliff that we can't do anything about from a tax planning standpoint. They will most certainly have a macro effect on the economy in my opinion but nothing that we can do anything about from a tax planning standpoint.
The main issues that we can deal with are the issues of income tax rates going up, capital gains tax rates going up, dividend tax rates going up, and estate tax rates going up. Let's look at some ideas for the different tax categories.
Income Taxes
If all of your income comes from an hourly wage or a salary then there isn't much you can do here. It is what it is. Those that are self-employed and those that are retired generally have more choices in this area. Having tax free investments is a good solution to deal with this but be careful because not all tax free options are necessarily a good idea right now. As an example Municipal bonds have a new risk in the last couple of years that they haven't seen before. If you're not sure what that is give me a call and I'd be glad to explain it to you.
Dividends
If we go over the fiscal cliff the tax on dividends will go up for most people. The rate will go from 15% to 43.9% for those in the highest tax bracket according to this article from Business Insider.com.
 | | (Click to read article) |
That's a heck of a jump. Essentially dividends will go back to being taxed at regular income tax rates. So what are some strategies here?
One would be to shift out of dividend paying investments and shift to investments where more of your growth will come from the appreciation of the asset instead of the dividend. Please note that if the dividend generating investment is in a qualified plan like an IRA it's not going to make any difference because you are taxed at income tax rates on qualified distributions anyway.
Here's another idea. For estate planning purposes a lot of people start a gifting plan for their kids and grandkids. Instead of gifting cash, why not gift some of your dividend paying assets to your kids or even better to your grandkids who are presumably in a lower tax bracket.
What a great way to teach the grandkids about money. Maybe they are in college. What a blessing it would be to be gifted an asset that would give them an extra $100 a month or whatever. Remember what it was like back when we were in college? But what if they sell it? Then they sell it. They didn't learn the lesson you were trying to teach them and so don't give them anymore.
Here is another idea. If you have some really good dividend producing investments, to the extent that you are able, use those investments to fund current year contributions to a Roth IRA. Current year contributions don't have to be funded with cash, they can be funded with contributions of shares. That way the dividends in the Roth IRA will be tax free for the rest of your life, unless Congress changes the law.
Capital Gains and Estate Taxes
Here is where you might want to take a look at your assets and decide if you want to harvest some gains. If we go off of the cliff, capital gains tax rates will be going from 15% to 20%. If you've got a $10,000 capital gain that means you will pay $1,500 this year but you will pay $2,000 next year. If putting that $500 in your pocket instead of the government's pocket is important to you then you might want to sell that asset by the end of the year to lock in that gain and pay the lower tax rate.
But what if you think that investment still "has legs" as the saying goes? If you have a relatively large capital gain you might want to consider selling to lock in that gain. Stay out of that investment for 30 days and then buy it back. That allows you to lock in the lower tax rate on the large gain while continuing to own the investment for anticipated future gains which will be taxed at the higher rate. But at least it will only be the future gains taxed at the higher rate vs. all the gains taxed at the higher rate. Your risk here is the gains that you may miss out on while you are out of the investment for 30 days. You have to weigh that against the tax savings to see if it is worth the risk.
As far as estate taxes, for any really large estates with a business to sell or something like that it is almost too late to make that happen by the end of the year. If we go over the cliff the estate tax exemption will drop from $3.5 million to $1 million. That's a huge difference, especially for groups of people like farmers and ranchers who are land rich but not necessarily money rich. If you have a complicated estate, I would highly encourage you to try and get a review of your estate plan as soon as possible to see what adjustments may need to be made.
Now once you have developed a plan and have your list of dividend producing assets and your list of assets that you may want to sell to lock in your gains you are at least prepared to act. As history unfolds right before our eyes you will have to make decisions about what you want to do. And please keep in mind that you may end up doing nothing. If in the end they come back and extend the tax cuts for all but the highest brackets, then you may not want to do anything.
Whatever you decide to do, I would highly suggest that you make those decisions with the guidance of your financial advisors and your tax professionals. Let's get ready to finish 2012 on a good strong note!
Until next week , Protect Your Wealth!
Sincerely,
  
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