4. SAY YES TO DEFERRED COMP
The accord in Washington offered some certainty about tax rates over the next few years - and the new rates favor deferred compensation strategies for executives, argues Daniel Yu, a financial planner and managing director of EisnerAmper Wealth Advisors in New York. "Now that we know that the top tax rate is 39.6%, I might dip my toe back into deferred compensation," he says.
But timing is key, Yu says. In qualified plans, the deferred compensation can grow tax-free and can then be rolled over into an IRA to continue the tax-advantaged growth. Because the top tax rate isn't likely to go higher for the next few years, retirees withdrawing their funds in the near future probably won't wind up paying more than the new top rate and can benefit from the tax deferral, Yu says.
Longer term, however, the tax picture becomes fuzzier, as a future Congress and president will likely take another swipe at deficits. So Yu is cautious on deferred comp as a strategy for younger workers. "Right now, my exposure is 39.6%, compared to ... what? The top rate could be 45% at some time in the future," he says.
5. MIND THE PHASE-OUT
With the wealthiest taxpayers now paying higher rates, you might in theory be advising your clients to bundle as many deductions into the current year, because the value of those deductions is greater at the higher tax rate.
But it's not that simple. Prior to 2010, itemized deductions were phased out for those who topped certain thresholds. The phase-outs were allowed to expire through 2012, but they're back now. "That's one of those stealth income tax increases that people may not notice for a while, unless somebody does an analysis of what their taxes would have been with and without the phase-out," Steffen says.
The phase-out limits taxpayers' ability to fully deduct charitable contributions, for instance, starting at $300,000 adjusted gross income for married filing jointly and $250,000 for single filers - both thresholds that are less than where the highest tax bracket kicks in.
For taxpayers whose adjusted gross income exceeds those upper limits, the itemized deductions (not including medical expenses, investment interest, casualty or theft losses or allowable gambling losses) will be reduced by the lesser of 3% of adjusted gross income in excess of the threshold amount, or 80% of the itemized deduction otherwise allowable for the tax year.
What to do? Well for one thing, don't be so fast to take those itemized deductions at once. And again, if adjusted gross income can be reduced, there is more likelihood of preserving as much of the value of deductions. "But people aren't always interested in reducing their income," Steffen says.
6. BUNDLE MEDICAL COSTS
Also changing this year is the threshhold at which your clients can deduct medical expenses, which is now 10% of adjusted gross income, up from 7.5%. Sarenski recommends an aggressive approach. "I would suggest loading up in one year, then not doing it the next year, and then [in the third year] do it again," he says.
Of course, it's not always possible to time medical expenses. But advise clients to replace a costly pair of eyeglasses, for example, during a year they do extensive dental work that's not covered, Sarenski says.
7. LOCATION, LOCATION
How you allocate assets is important, but so is where you keep those assets. So the tax increases might be a good time to reconsider which assets to hold in tax-sheltered accounts. Assets that give off taxable income, and are therefore tax inefficient, are best held in tax-deferred vehicles like 401(k)s and IRAs. Investments with significant capital appreciation, however, can reside in taxable accounts because rates on long-term gains are only rising to 20% (or 23.8% for high earners, with that Medicare surtax), and because you and your clients can control when to realize those gains.
Note that income from Treasury inflation-protected securities, bonds and REITs are taxed at the ordinary tax rate. "Stocks go into a taxable account, but TIPS and REITs go into a tax deferred," says Jean-Luc Bourdon of Brightpath Wealth Planning in Santa Barbara, Calif.
Be careful about selling securities that would generate gains just to move them, though. That wouldn't be terribly tax efficient, would it?
8. MUNIS MORE THAN EVER
For many advisors, municipal bonds are the go-to source of tax-free income. This year, they're an even better deal because their income isn't subject to the Medicare surtax. Buying in-state munis also nets filers dual tax-free income - especially important in high tax states like California, New York and New Jersey.