cliff4 financial moves to consider, regardless of the final outcome.

We’ve been receiving a lot of phone calls since the presidential election about the upcoming tax increases and government spending cuts – popularly known as the fiscal cliff. The “cliff” is caused by the expiration of Bush-era tax cuts along with other pro-taxpayer provisions (like higher Alternative Minimum Tax exemptions), plus spending cuts mandated by the Budget Control act of 2011.

If Congress can’t reach an agreement, Federal income tax, long term capital gains tax, and estate tax rates will go up for many of you reading this article, and estate tax exclusions will go down. Even if Congress reaches a compromise between vacations, two things are almost certain:

  1. Some people will have to pay more taxes.
  2. It will be a temporary solution.

Minimizing the Impact of the Fiscal Cliff

I’m sorry that I can’t deliver better news, but there are some things that you should consider, regardless of any Congressional action, as you prepare for upcoming tax changes.

  • Take your income, gains, and dividends in 2012. Between Bush-era tax cut expiration and healthcare taxes, the capital gains rate, including both Federal and Georgia taxes, will be as high as 31% for some. Taxes on dividends could go as high as 43%. For all of these reasons, consider limiting your tax liability by recognizing income and gains in 2012. You can always buy stocks back next year to create a higher basis – lowering your future tax bill.
  • Defer tax deductions. Making charitable donations, paying your business bills, and delaying estimated tax payments until January will reduce your taxable income as tax rates increase. There are a couple of caveats here. First, watch out for Alternative Minimum Tax (AMT) implications. Second, watch out for last minute changes to 2013 itemized deductions and personal exemptions, which may make better to take some deductions in 2012.
  • Convert regular IRAs to Roth IRAs. Where traditional IRAs are taxed when you take the distributions, Roth IRAs are tax-free for the life of the account. The down side to converting now is that you have to pay taxes on the amount you convert, but you can do so at lower 2012 rates. Contributing more to your retirement plans in 2013 will also reduce your taxable income and potentially keep you below the threshold for higher taxes.
  • Make financial gifts now. You can “gift” up to $13,000 to anyone under an annual exclusion with no tax consequences. Through 2012, you can also give up to $5,120,000 as part of a separate lifetime maximum gift exemption. For larger gifts, we can talk to you about setting up entities in which to place these funds, such as through Family Limited Partnerships. You will need to complete these transactions by December 31, 2012 because the laws in this area will likely change.

Confused? You are not alone. The fact that Congress is still bickering this late in the year makes it very difficult to plan when you don’t know the ultimate outcome. If you are still hoping for the best, you can set up your financial transactions and then determine whether or not to pull the trigger once a fiscal cliff decision (if any) is made. With all of the meetings between Congress and the President, there’s a chance that you may still see some positive impact.

Neal Bach, CPA