The good news is clients still have time to take advantage of 2012 tax rates, which may turn out to be the lowest available for some time. Rodgers offers three strategies that can be implemented before the end of the year:
Do a Roth Conversion
Converting a traditional IRA to a Roth IRA creates a taxable event in 2012, Rodgers says. All future earnings in the account will be tax-free, as long as you wait five years and are age 59½ or older when you take withdrawals. But, he points out, the single biggest advantage to doing a Roth conversion now is the ability to “undo” the transaction as late as Oct. 15, 2013.
“Should the new Congress pass a major tax reform bill next year that lowers tax rates across the board, you can put the money back into your IRA,” Rodgers says. “It will be like the transaction never happened.”
Harvest Capital Gains
Sell appreciated securities that you’ve held for at least 12 months to realize the long-term gain for tax purposes, Rodgers says. You can immediately repurchase the same asset because there is no wash sale rule for realizing gains. This allows you to pay tax on the gain in 2012, when rates are low, and establish a new cost basis in the asset to minimize increased gains that may be taxed at higher rates, according to Rodgers.
This strategy should appeal to anyone in the 15% tax bracket because capital gains are taxed at zero and may jump as high as 8% to 10% in 2013 if the tax cuts expire. The strategy is also appealing to anyone subject to the Medicare surtax. If the current tax laws expire, the tax rate on long-term capital gains will jump from 15% to 23.8% (21.8% for assets held more than five years), he says.
Pay Medical Expenses
Anyone who normally itemizes medical expenses on their tax return should accelerate those expenses into 2012 if they can, the planner advises. Medical expenses are deductible only if they exceed 7.5% of adjusted gross income (AGI). This means if a client’s AGI is $50,000, he can deduct only medical expenses over $3,750. Next year the threshold jumps to 10% of AGI.
Clients can also pay their January medical insurance premiums in December to move this deduction to 2012. Any routine eye exams or dental visits should be moved up to December. Paying with a credit card would give you the deduction this year and delay the actual payment until 2013, he says.
Rodgers warns that a common mistake people make is to wait and see what happens. It has not been uncommon for Congress to announce significant changes to the tax code late in December, leaving taxpayers little time to react.
Overall, Rodgers advises a diversified approach to tax planning: Make a partial Roth conversion, harvest some capital gains but don’t wait until it’s too late to do anything about rising taxes.
