Year end 2012 tax planning tips below are broken into the follow categories:
- For Income Levels Expected to Be Under $70,000 (married) $35,000 Single
- For Those Who Lost a Job or Retired Early in the Year
- For Those Who Retired Late in the Year or May Retire Next Year
- For Earners With Income in Excess of $70,000 Married, $35,000 Single
- For Those With Expected Income of $250,000 or More
- For Those Age 63 and Older
- For Those Reaching Age 70
Find the section(s) that applies to you to find specific year-end tax planning tips.
1. For Taxable Income Levels Expected to Be Under $70,000 Married, $35,000 Single
See If You Can Realize Gains and Pay No Tax
If you own stocks or funds in a non-retirement account, and you will be in or under the 15% tax bracket, you may be able to realize capital gains and pay no tax. For 2012, the tax rate on long term capital gains is zero percent for those in the 10% and 15% tax brackets. This rate is set to expire at year end.
What to do? You will need to do a tax projection to estimate your income and capital gains before and after any anticipated changes. If there is room for additional capital gains that will incur no tax, don’t hesitate. Realize the gains. This year end tax planning strategy can allow you to have tax-free gains. The zero percent rate is scheduled to expire after 2012 so you have to act before year end.
Caution 1: You can only use this feature to realize gains in an amount that “fills up” to the 15% bracket. Meaning if you had NO other income you could have about $90,000 of gain as a married filer ($45,000 as a single filer) that would be eligible for the zero percent rate. (That gain number is expressed as adjusted gross income assuming a married filer has a standard deduction of $11,900 and two personal exemptions of $3,800 each, a single filer having a standard deduction of $5,950 and one exemption of $3,800, it would leave the married filer with approximately $70,000 of taxable income and the single filer with approximately $35,000 of taxable income.)This works because those taxable income numbers are the cutoff amounts where income over those amounts is taxed at the next higher tax bracket. As a married filer, if you have $50,000 of income already, that leaves you with room for about $20,000 of long term capital gain that may be eligible for the zero percent rate.
Caution 2: If you have capital losses from previous years, your current year capital gain will use up those losses first. In that situation, depending on the amount of losses, it may not be advantageous to realize the gain in 2012. You may want to save those losses for use against future capital gains that may be taxed at a higher rate.
Best for: I recommend intentionally realizing gain for those who will be in or under the 15% bracket and who have no capital loss carryforward. Intentionally realizing the gain can involve an exchange, such as exchanging one S&P 500 stock index fund for another similar S&P 500 stock index fund.
2. For Those Who Lost a Job or Retired Early in the Year
Go for ROTH Conversions
If you lost a job or retired early in the year your may have very little or no taxable income for the year. Particularly if you itemize deductions you’ll want to take a close look at this.
What to do? Low income years can result in a tax situation where you have more deductions than income. In those years you may be able to convert a portion of a traditional IRA to a ROTH and pay no tax. You would convert a sufficient amount to match the amount of deductions you have, leaving your taxable income at zero. Or if you expect to be in a higher tax bracket later, you may convert enough to fill up the 10% or 15% tax brackets. You will only uncover this opportunity by doing year-end tax planning before December 31st.
Best for: Those with more deductions than income and those who expect to be in a higher tax bracket later when they will need to take IRA withdrawals.
3. For Those Who Retired Late in the Year or May Retire Next Year
If you retired late in the year or plan on retiring next year, you may see a substantial change in your tax situation.
What to do? If your employment status change means your tax bracket will be lower next year, you may want to see if you can defer income or bonuses from this tax year into a future year where your tax bracket will be lower.
Best for: Those who expect to have lower income next year or in future years than in this current year.
4. For Earners With Taxable Income in Excess of $70,000 Married, $35,000 Single
Many people are anticipating that capital gains and dividend tax rates may be higher in the future.
What to do? If that turns out to be the case it makes sense to intentionally realize gains now by selling or exchanging your appreciated stocks, mutual funds or property before year end, and pay tax at the 15% federal rate. You would do this to avoid paying tax on this gain at a potentially higher rate in future years.
Caution 1: In normal years certain exemptions and deductions are phased out at high income levels, which means additional gains could cause you to lose other deductions, but for 2012 this personal exemption phase-out and itemized deduction limitation remains repealed.
Caution 2: For older tax payers who live in a community property state, your spouse will receive what is called a step up in basis on non-retirement account community property assets upon your death, which means they may be able to avoid capital gains any way. Don’t realize gains just for tax reasons if you realistically think you won’t need to sell the assets prior to your death. You may be accelerating a tax that could have been avoided all together.
Best for: Tax payers who anticipate needing to sell appreciated assets a few years out and think the capital gains tax rates may be higher then.
5. For Those With Expected Income Greater Than $250,000 for Marrieds, $200,000 for Singles
Watch Out for The Medicare Surtax
Starting in 2013 there will be a Medicare surtax for high income earners. It will be a 3.8% tax that applies to unearned income in excess of certain thresholds.
What to do? You can reposition non-retirement savings and investments to reduce taxable income that might cause you to be subject to the Medicare surtax in future years. For example, municipal bond income will not be subject to this surtax.
Best for: High income tax payers with lots of investment income that is not sheltered in tax deferred accounts.
6. For Those Age 63 and Older
Each year your Medicare Part B premiums are determined by looking at your tax return two years prior. If you have a year with high income, even if it was due to a one-time event such as the sale of a piece of property, it may cause your Medicare Part B Premiums to be higher two years later.
What to do? See if there is a way to spread gains and income over more than one tax year to avoid crossing the Medicare Part B threshold in any one year.
Best for: People 63 or older who anticipate realizing capital gains or perhaps an installment sale (from the sale of a business for example) who could spread the realization of income out over more than one tax year to stay under the Medicare Part B threshold.
7. For Those Reaching Age 70
At age 70 ½ you must begin taking required minimum distributions from retirement accounts. This extra taxable income can also make more of your Social Security benefits subject to taxation. This causes many people who start required minimum distributions get caught off guard by a larger than expected tax bill.
What to do? Year-end tax planning will help you accurately estimate your new tax bill so you have the appropriate amount of tax withholding taken from your IRA distributions.
Best for: Anyone who is starting their required minimum distributions for the first time.
See more Year End Tax Tips.