Seven tax actions to take before it's too late
With the possibility that the “Bush tax cuts” will be allowed to expire at the end of the year, 2012 tax planning should start now. While some tax reduction approaches can be postponed, here are seven techniques that may require action in early 2012:
- Selling a Business or Real Estate: In 2013, long term capital gains taxes on all investments, including privately owned businesses or real estate, could increase by 33 percent, from an effective tax rate of 15 percent to an effective tax rate of 20 percent. If your business or real estate is worth $250,000 or more, an additional 3.8 percent “Medicare” tax will be added to your 2013 tax bill. Thus, waiting until 2013 to sell a highly appreciated property or business could increase your federal taxes on the sale by 58 percent.
- Paying for College with a 529 Plan: While funding a Colorado College Invest 529 Plan is not deductible on federal income taxes, for Colorado residents this funding receives a Colorado state tax deduction of the yearly amount funded. The deduction also applies to funds for children that are already in college. If your child’s fall college payments are due this summer, put the full amount required into the College Invest 529 Plan’s Money Market account. When the college payments are due, send these funds to your child’s college. Using this funding technique could reduce your Colorado income tax bill by $1,860, if your child’s qualified college expenses are $40,000 a year.
- Set-up a SIMPLE IRA: If you run a small business with one or more employees, consider a SIMPLE IRA. This retirement plan allows a business owner to make tax deferred contributions of $11,500 or $14,000 if the owner is over age 50. The business will also contribute either 2 percent or 3 percent of employee’s salaries (including the owner’s salary) to each employee’s SIMPLE IRA. SIMPLE IRA Plans must be established before Oct. 1 to qualify for that year.
- Roth IRA Conversion: Convert a traditional IRA to a Roth IRA as early in the year as possible. If the market goes up, the converted funds receive tax free growth. If the market declines significantly, you may convert (recharacterize) these funds back into the traditional IRA. If the funds are “recharacterized” before December, they can be converted back to the Roth IRA, after waiting for thirty days. Even if the market declines next year, you can still “recharacterize” Roth converted funds until Oct. 1, 2013.
- Medical Expense Deductions: If you will need medical services that are not covered by medical insurance, get them done in 2012. If your Adjusted Gross Income (AGI) is $50,000, only medical expenses above $3,750 will be deductible in 2012. Thus, if your medical expenses are $5,000 in 2012, you will have a $1,250 itemized deduction. However, in 2013, the non-deductible medical amount will increase from 7.5 percent to 10 percent of AGI. Thus, the same $5,000 medical expense will not be tax deductible.
- Save those Sales Receipts: The ability to deduct sales taxes instead of state income taxes has not been renewed for 2012. With the large number of Democrat and Republican states with low or no income tax, it is likely that this deduction will be reinstituted before the end of 2012. If so, saving sales receipts, especially for large ticket items like car purchases, may reduce federal taxes owed, especially for those who owe little in state income taxes.
- Allocations Between Taxable and Tax Deferred/Free Accounts: In 2012, high dividend paying stocks and mutual funds are very tax efficient. In 2013, not only will long term gains likely increase by 33 percent, but the taxes on dividends could almost triple for high earners. Now is the time to begin planning a portfolio for tax optimization in 2013. Holding growth stock/funds, with little or no dividends, in taxable accounts and high dividend stocks/funds in tax deferred accounts could be very tax effective in 2013.
These suggested tax saving steps may significantly lower federal and state taxes in 2012 and beyond. Procrastination in 2012 could cost you considerably, in current and future taxes. Visit with a qualified financial advisor or tax adviser to help determine the 2012 tax strategies that will work for you.