By Barbara Weltman
This year, traditional December tax planning has been made more challenging because of tax law uncertainty: What will the tax rates be in 2013? Will current estate and gift tax rules be extended? How will new tax rules under the Affordable Care Act (“Obamacare”), which start in 2013, interact with other tax rules?
Despite uncertainty, there are opportunities to make smart year-end tax moves. Here are five ideas.
1. Take capital gains now
Most people are reluctant to pay one penny of tax a day before they have to. Yet the possibility that the top capital gains rate will rise from 15% in 2012 to 20% in 2013 (at least for high-income taxpayers), combined with a new 3.8% additional Medicare tax on net investment income for high-income taxpayers that starts next year, suggests that taking year-end gains may save future taxes.
Advantages to taking gains. Selling appreciated securities by December insures the gain will be taxed at 15%, avoiding the risk of a rate increase in 2013.
Selling and then reacquiring the same securities allows you to effectively re-set your tax basis in those holdings and avoid the 3.8% additional Medicare tax in 2013 on the pre-sale appreciation.
For example, say you have 100 shares of X Corp. that you bought years ago for $10 per share (basis is 100 shares x $10 = $1,000). The shares are now trading at $45 per share. If you sell now, your capital gain is $3,500 ($4,500 - $1,000); the tax cost is $525 ($3,500 gain x 15% capital gain rate). You can immediately buy the same shares for $45 per share, giving you a new tax basis of $4,500.
If you wait until 2013 to sell (assume they stay at $45 per share), and you are subject to a 20% capital gain rate plus the additional Medicare tax, the delay would cost you 8.8% more in taxes. Instead of paying $525 in tax on the sale, you’d pay $833 (20% of $3,500 gain + 3.8% of the gain).
Advantage for taxpayers in the 10% or 15% brackets. These individuals pay no tax on capital gains in 2012. This may be the last year that there is a free ride for such gains, so sales of appreciated property might best be concluded this year.
Disadvantage to taking gains. You’ll have a tax cost for 2012 on your profits, unless gains can be offset by capital losses (see below).
Reminder: Selling securities should primarily be based on financial considerations; taxes are only one factor.
2. Harvest capital losses
It never hurts, from both a financial and tax perspective, to take capital losses. Capital losses can be used to offset capital gains. If there are any excess losses, they can offset up to $3,000 of ordinary income, such as interest and wages. Any excess losses for 2012 over this offset can be carried forward indefinitely for use in future years, when they will be even more valuable if capital gain rates rise.
Caution: Avoid the wash sale rule that bars you from recognizing losses if you acquire substantially identical securities within 30 days before or after the date of sale (the wash sale rule does not apply to gains).
3. Consider charitable giving
No one is sure how deductions for charitable contributions may be affected by new tax rules for 2013. On the one hand, if tax rates rise, the value of this write-off increases. On the other hand, if Congress imposes a limitation on itemized deductions for high-income individuals (as existed prior to 2010), then some of the tax benefit from charitable contributions will be lost.
Using the bird-in-the-hand theory, giving to IRS-recognized charities before the end of this year will nail down a tax deduction and save you money on your 2012 return.
Caution: Be sure to follow substantiation requirements for charitable gifts.
4. Make discretionary medical expenditures
If you’ve been thinking about some elective medical expenditures, such as dental work or prescription sunglasses, now may be the time to do it. Costs that are not covered by insurance or reimbursed through a medical flexible spending account (FSA), health savings account (HSA), or health reimbursement account (HRA) are part of an itemized deduction for medical expenses.
However, only costs over a threshold amount can be written off. For 2012, the threshold is 7.5% of your adjusted gross income (AGI). Starting in 2013, the threshold jumps to 10% of AGI, making it more difficult for high-income individuals to deduct out-of-pocket medical costs. While most individuals face the 10%-of-AGI threshold, those who are 65 or older by the end of the year can continue to use the 7.5% threshold through 2016.
Also, if you have a medical FSA, use up your 2012 contributions before you lose them. You usually have until December 31 to do this, but some plans give you a grace period until March 15 of the following year to act; check with your plan administrator.
5. Make gifts
Congress has yet to decide what the gift tax rules will be in 2013 and beyond, and so wealthy individuals who can afford to give away some of their money now in order to reduce future estate taxes may want to do so before the end of the year. An individual who has not made prior taxable gifts can make up to $5.12 million of gifts in 2012 with no federal gift tax, and this is in addition to gifts covered by the 2012 exclusion of $13,000 per recipient. Gifts over these limits are taxed in 2012 at no more than 35%.
Each person’s tax picture is different. Discuss yours with your tax advisor before implementing year-end tax saving strategies.
Barbara Weltman is an attorney and a nationally recognized expert in taxation for small businesses, as well as the author of many top-selling books on taxes and finance, including J.K. Lasser's 1001 Deductions and Tax Breaks. She is also the publisher of Idea of the Day, a guest columnist for WSJ.com and contributor to SBA.gov, is quoted regularly in major publications (including the New York Times, the Wall Street Journal, and Money magazine), and hosts Build Your Business radio. Visit her at www.barbaraweltman.com.