With the election out of the way and efforts taking shape in Washington to resolve the threat of automatic tax increases and the fiscal cliff, accountants and financial planners are recommending ways to protect their clients no matter what Congress and the Obama administration ultimately decide to do about the tax laws in 2013.
Rick Rodgers, president of Rodgers & Associates, in Lancaster, Pa., urged clients to diversify their income by putting it in various types of retirement accounts and investments. He told them to "put some money into a Roth IRA because the withdrawals will be tax free, and into tax-deferred accounts like a 401(k) or a 403(b) because you get the immediate tax benefits [in 2012]. Then save some money after tax because currently the earnings on investments in after-tax accounts are preferential in terms of qualified dividends and long-term capital gains. That way, you have your money in three different places. Going forward, we don't know what's going to happen with the tax laws, but that way you're somewhat covered as opposed to making a big bet one way or the other."
Rodgers also said that he doesn't believe "that anybody thinks this current system of patch and postpone is good for anybody. Here we are again wondering what's going to happen with the current tax laws. For tax preparers, CPAs and financial planners, how do we advise clients?"
Mark Fagan, a CPA and managing partner of Citrin Cooperman, has several predictions about what the Obama administration might propose. "The top individual income tax rate of 35% will revert back to 39.6% for all earners above $250,000," he said. "The tax rate for dividend income will increase from 15% to 39.6% for earners above $250,000," he added. "Long-term capital gains rates are expected to increase from 15% to 20% for earners over $250,000. The alternative minimum tax will be extended. The corporate tax rate may actually decrease from 35% to 28%, but corporations will lose certain deductions. Renewable energy credits are expected to be extended under Obama."
But the question is whether such proposals from the administration will be able to make it through the Republican House and the Democrat-controlled Senate. "I believe the long-term capital gains tax will get through Congress, and there is a strong chance the individual rates will increase," Fagan said.
One of the unresolved issues is the alternative minimum tax, which has not yet been patched to prevent it from applying to millions more taxpayers next year. "We could say we think the alternative minimum tax is going to be patched, but nobody really knows if that's going to happen," Rodgers said. "We're going to be dealing with that forever unless we have tax reform. The President has said that he wants to get rid of the alternative minimum tax, but he hasn't been specific on how he proposes doing it."
Meanwhile, Rodgers advised clients to do a Roth IRA conversion before the end of last year. "The great thing about the Roth conversion is that we can decide up until Oct. 15, 2013 to undo it," he said. "So we can do a Roth conversion anticipating that rates will go up, or some kind of thing will happen with the tax code that is unfavorable. But if we find out that doesn't happen, or if maybe tax reform goes through and we should not have done a Roth conversion, we can always undo it. So since we can undo it, why not do it? For most people, if you can afford to pay the tax on it and you end up keeping the Roth conversion, do a Roth conversion for more than you think you should because you can always undo part of it as well, so it's not an all or nothing."
Rodgers also has advised clients to take capital gains in 2012. "That applies to two sets of people," he said. "The first one would be anybody who can take capital gains in the 15% bracket because currently, in that bracket, capital gains are taxed at zero. The only thing that you have to consider when taking capital gains is if you live in a state that has state income tax and that applies to capital gains. You seriously need to consider doing that [in 2012]. Even if you like the security, take the capital gain and then buy it back."
Rodgers said taxpayers who will be subject to the additional 3.8% tax on investment income under the Affordable Care Act should consider taking capital gains to re-establish their cost basis. "If you know your income is going to be over $250,000 [this] year, accelerating capital gains into  it's going to be taxed at 15%," he said. "[In 2013], it's going to be 18.8%. But if you're between $70,000 in taxable income and $250,000 in adjusted gross, that's really a unique situation that involves some serious planning." Another type of client who needs to be wary is one who itemizes medical deductions, Rodgers said. Total medical expenses in excess of 7.5% of a taxpayer's adjusted gross income can be deducted in 2012, but this year the threshold will rise to 10%.
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