Plan now for potential tax changes

It's almost time to dust off Plan B for tax planning.

Plan A assumed Congress would get its act together and pass legislation clarifying tax details for the coming year. That might still happen, but each tick of the clock makes it a bit less likely.

Like a kid who blames the dog for eating his homework, Congress has a track record of missing deadlines and making tax fixes retroactively. So it's prudent to consider some of the what-if scenarios that fall under Plan B.

• Changing brackets.

Start with ordinary income-tax rates, which currently range from 10 to 35 percent. They're set to expire Jan. 1, ushering in new rates of 15 to 39.6 percent if no action is taken.

It's also possible current tax rates could be retained entirely or in part. One scenario would keep current rates for moderate-income taxpayers but bump them up for single filers earning more than $200,000 and couples making above $250,000.

Typical tax planning thus could get turned upside down. As a rule, taxpayers usually prefer to maximize their deductions in the current year and defer income to the next. But if rates rise, that thinking might not apply this time around.

As an example of a reverse strategy, you might consider pulling more money than normal from your individual retirement account this year while tax rates are low, suggests Stephen Harnden, a certified public accountant and certified financial planner at Ameriprise in Sun City.

That would make most sense for lower-income people who are past age 59 1/2 and thus wouldn't face an early withdrawal penalty. Harnden cautions to beware unintended consequences such as triggering taxes on Social Security income.

As for deductions, it might pay to defer certain expenses that you'd normally pay before year-end, said Eric Voita, tax director at GenSpring Family Offices in Phoenix.

For example, if feasible, you might want to hold off until January on paying any state income taxes that are due, real-estate taxes, various business expenses and loan payments on which interest can be deducted, he said.

• Gains and dividends.

Investors face two big changes in the absence of new legislation. One involves a boost in long-term capital-gains rates from the current range of 0 to 15 percent. After Dec. 31, investors could pay rates from 10 to 20 percent.

Also, levies on qualified dividends could rise. Dividends now are taxed at capital-gain rates but face treatment again as ordinary income, at levies up to 39.6 percent.

If dividend tax rates do rise, you might want to shift more of your yield-oriented stocks, bonds and mutual funds to IRAs or other sheltered accounts, while taking a fresh look at muni bonds or bond funds.

Since municipals pay tax-free income, they're suitable in a rising-tax environment. They might even represent bargains at today's prices.

"It is my guess that much of the likelihood of future tax-rate increases has not yet been factored into municipal bond pricing," Harnden said.

• Gains and losses.

Then there's the issue of sorting through your gains and losses. If capital-gain rates are heading higher, it might pay to sell profitable investments this year to lock in the lower rates. It also might pay to delay taking losses so they can offset future profits at higher capital-gain rates.

Harnden suggests analyzing your portfolio at least once a year with an eye on offsetting gains with losses and carrying unused losses forward "to soak up future capital gains as they occur."

The analysis applies to stocks, funds and other assets in taxable accounts.

Even if you don't take action on these points, consider how your assets might be affected by tax moves made by others.

For example, a hike in dividend tax rates could spark selling in stocks that pay dividends, said Harry Papp, an investment adviser at L. Roy Papp & Associates in Phoenix.

He views REITs, or real-estate investment trusts, as especially vulnerable because they pay some of the highest yields around and operate in one of the most troubled industries.

• Odds and ends.

Many other tax changes are looming. Researcher CCH notes that legislation is pending that would extend more than 60 tax items that expired in 2009. If enacted, the bill would continue provisions such as the optional deduction for state/local sales taxes and the above-the-line deduction for college expenses. But they'll disappear if no action is taken.

Even more provisions are set to expire at the end of 2010. One is the American Opportunity Tax Credit for college and various credits to make homes more energy-efficient.

All of these tax topics provide many things to think about, even if it's still premature for decisions.

"Nobody's acting on them yet," Voita said. "But my guess is December could be one of the busiest months in years for certain types of transactions."

by Russ Wiles The Arizona Republic Oct. 17, 2010 12:00 AM



Plan now for potential tax changes