New Tax, New Planning


July 26, 2012


At the start of next year (2013), America's entire tax regime is set to change, as the Bush-era tax rates shift back to their previous (higher) levels, and preferential (lower) rates on capital gains and dividends phase out. The estate tax rates will go up and the exclusion amounts will go down. Congress may intercede between now and then, but in an election year, any meaningful compromise is far from certain.



This has created an unusual level of uncertainty among financial advisors and planners. However, the recent Supreme Court ruling on the 2010 Patient Protection Affordable Care Act (sometimes colloquially referred to as "Obamacare") has taken one uncertainty off the table. We now know that a new tax will have to be planned for as of January 1. As a way of shoring up the shaky finances of our Medicare Trust Fund, the budget reconciliation bill that was passed in conjunction with the health care reform bill will impose a 3.8% "Medicare Contribution" tax starting in tax year 2013.



What does that mean to you? For 97% of all households--individuals whose current taxable income falls below $200,000, or couples with a joint income below $250,000--the tax is irrelevant; it only applies to persons above those income thresholds. (Technically, the actual number would be a modified adjusted gross income.)



For example, suppose a husband and wife completed their tax forms, and found that they had adjusted gross income of $400,000 in 2013. The first number that the 3.8% tax might be applied to is $150,000 ($400,000 - $250,000). Moving to the second test, let's suppose that they earned interest income amounting to $40,000, and had sold some stocks for a capital gains profit of another $40,000. But they had also sold some stocks at a loss, amounting to $15,000. Their net investment income comes to $65,000. That's obviously lower than $150,000, so that is the amount on which the couple pays the Medicare Contribution tax. Their MC tax comes to $2,470.



Suppose the couple only earned $265,000 in that same year. They would pay taxes on $15,000 ($265,000 - $250,000), rather than on the investment income.



You might have read that this tax will be imposed on the gains from the sale of your house, but that may NOT be true. If your income is above the threshold limit, you and your spouse would still have to make a profit of more than $500,000 ($250,000 for singles) on the sale of your house before the tax becomes applicable.


The investment calculation does NOT include payouts from a regular or Roth IRA, 401(k) plan, Social Security or veterans' benefits, or any income from a business on which you are paying self-employment tax. It also doesn't apply to the appreciation of your stocks or mutual funds until or unless they're sold and gains are taken. However, IRA and qualified plan distributions DO raise your modified adjusted gross income, and this, of course, can put you over the threshold.



What should you do now? Normally we recommend deferring income into next year, and accelerating expenses into the current year, when possible. For 2012, because of the new taxes that will go into effect in 2012, and the possibility of Long Term Capital Gains taxes increasing to 20% from 15%, we recommend the following:

1. Accelerate income into 2012 wherever possible,

2. Sell stocks and mutual funds on which you have gains in 2012

3. Defer deductions and losses until 2013

4. Consider converting IRA assets into Roth IRA assets in 2012.



Distributions from the Roth IRA never show up in any of these 3.8% calculations, and the money paid up-front in taxes lowers the taxable income amounts in the future. As a potential bonus, the tax rates in 2012 might be lower than they would be if all the tax rates jump on January 1.



Still, it is important to remember that taxes are only one component of your total investment picture. A strategy that simply tries to lower your payments to Uncle Sam may not be the best one for your personal needs, or for building retirement income.



If you have any questions about your individual situation, please give us a call. Enjoy the rest of the summer and stay cool!





Edward J. Kohlhepp, CFP®, ChFC, CLU, CPC, MSPA

Edward J. Kohlhepp, Jr., CFP®, MBA

Please contact us whenever there are any changes to your financial situation, personal situation or investment objectives.






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Kohlhepp Investment Advisors, Ltd.
3655 Route 202, Suite 100
Doylestown, PA 18902
Phone: 215-340-5777
Fax: 215-340-5788

Securities offered through Cambridge Investment Research, Inc. a Registered Broker/Dealer, Member FINRA/SIPC. Investment Advisory Services offered through Kohlhepp Investment Advisors, Ltd., a Registered Investment Advisor. Kohlhepp Investment Advisors, Ltd. and Cambridge Investment Research Advisors, Inc. are not affiliated.

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