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By Jason Stipp | 12-29-2011 02:00 PM

Higher Investment Taxes on the Horizon

Ernst & Young tax partner Greg Rosica offer tips for investors in light of the pending expiration of Bush-era tax cuts at the end of 2012.

Jason Stipp: I'm Jason Stipp for Morningstar.

At the start of a new year, investors turn their attention to the often-dreaded task of filing their taxes.

Joining me today is Greg Rosica--he is a tax partner at Ernst & Young and contributing author to the Ernst & Young Tax Guide for 2012--to offer some tips about what should be on your radar screen and how you can take some of the stress out of tax-filing tasks?

Thanks for joining me, Greg.

Greg Rosica: Thanks for having me. Pleasure to be here.

Stipp: The first question for you: I think, from an investor's standpoint among the biggest changes that we could see next year is the possible expiration of the Bush-era tax cuts at the end of 2012. If those tax cuts expire, what does that mean, what does it reset to?

Rosica: So really where we are is, it's not an if at this point; they will expire. Based on the existing law that we have, at the end of 2012 those tax cuts we've enjoyed since the early 2000s do expire.

And what happens at that point, pending any other legislation, would be that the tax rates go back up to the pre-2000 era levels, which is, top rates of 39.6% for ordinary income, capital gains rates going back up, as well, from 15% back up to 20%. And then, in addition to that, we have other provisions that are in the law as well that will affect investors, such as the 3.8% surtax for the health insurance bill that was passed a year or so ago--that gets added on to those rates as well. So, you can see some very high tax rates that are in the law scheduled to take place January 1, 2013, unless some other legislation intervenes prior to that.

Stipp: So given that right now, it is a certainty, unless, as you mentioned, there is some intervention ... what kinds of questions should investors be asking themselves as they are looking at the portfolio in light of the fact that unless something happens, we will see these higher tax rates?

Rosica: You really need to look at your portfolio from the investment and the soundness of the investments that you have primarily, and not let the tax situation drive that.

But having said that, the difference between selling something at the end of 2012 and the beginning of 2013, may be a couple days or a month or two months difference, could be a significant decrease to your portfolio if the tax rates do in fact go up.

So I think examining it as we get closer to the situation and determining what the right investment move is for you and then overlaying what the tax consequences will be--maybe in two different scenarios, meaning at the end of 2012 versus the beginning of 2013, what that net-net might look like.

If you are a longer-term investor, and you are not going to be selling something early in 2013 or even until 2014, then you really need to look at that difference in the tax rates and the impact on that vis-à-vis what the investment performance might be and the present value of that money as well.

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