It is important to monitor developments in Washington to make sure you understand how tax legislation could affect your situation.
When reviewing the impact of taxes on your investments, it is important to understand that many items currently in the federal tax code are scheduled to expire after December 31, 2012. Although future actions to amend tax rules are anyone’s guess, keeping abreast of developments in this area may be to your advantage. Consider the following when making decisions about your investments during 2012.
- When taking capital gains, make them long term. Legislation passed by Congress in 2010 continues the 15% tax rate on long-term investment gains, those generated on investments held for more than one year, through December 31, 2012. In contrast, short-term capital gains on investments held for one year or less are taxed as ordinary income, where marginal tax rates currently can be as high as 35%, depending on how much you earn.
- Tax rates on qualified dividends are subject to change. Current tax rules maintain the favorable 15% tax rate on qualified dividends through December 31, 2012. Although dividends are not guaranteed, an allocation to dividend-paying investments may provide an ongoing source of income that can cushion the ups and downs of capital gains and losses. The opportunities are plentiful: As of February 2012, 395 of the 500 companies within the S&P 500 paid a dividend.1
- Accelerate activities that generate higher taxes. The top four federal income tax rates will be maintained at 25%, 28%, 33%, and 35% through December 31, 2012. If you are considering an activity that is likely to result in a bump in your income or a federal tax payment, you may want to complete it while the lower rates remain in effect. Examples could include converting a traditional IRA to a Roth IRA and selling real estate or a business that has appreciated significantly in value.2
- Escalate gifting strategies. Through December 31, 2012, estates valued at more than $5.12 million are subject to a federal estate tax rate of 35%. In addition, the tax code “unified” the estate tax and the gift tax, permitting an individual to gift $5.12 million between now and December 31, 2012, without triggering the federal gift tax. Rules relating to estate planning are complex, so be sure to seek counsel from a qualified attorney before taking action.
- Capitalize on tax-advantaged accounts. By contributing regularly to an IRA, and keeping the money invested until qualified withdrawals are made, you can benefit from tax-free compounding. With a traditional IRA, qualified withdrawals after age 70½ are taxed as income. In certain instances, if investors adhere to income thresholds established by the Internal Revenue Service, contributions may be tax deductible. With a Roth IRA, contributions are never tax deductible but qualified withdrawals after age 59½ are tax free. Maximum contributions for either the 2011 tax year (must be made by April 15, 2012) or the 2012 tax year (must be made by April 15, 2013) are $5,000 per taxpayer, plus an additional $1,000 catch-up contribution for those aged 50 and older.
There may be additional items unique to your situation, but these tax moves can help you make the most of your hard-earned dollars during 2012.
1Source: Standard & Poor’s.
2Restrictions, penalties, and taxes may apply. Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted.
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