The Error-Proof Portfolio: Anticipating 2013 Tax Changes Could Save You Some Dough
Advanced planning can help reduce your tax bills if and when tax rates pop back up.
Advanced planning can help reduce your tax bills if and when tax rates pop back up.
Investors have had a tough slog during the past decade, but you can't say it's because of the tax regime. Dividends, taxable as ordinary income during the late great bull market of the 1980s and 1990s, have been taxed at or below 15% since 2003, provided they meet certain criteria. The same goes for long-term capital gains, which were taxed at rates of 28% or higher as recently as the late 1990s.
But all of that is set to change in 2013. Barring congressional action, dividends will again be taxable at ordinary income tax rates starting next year, and the highest income tax rate will pop up from 35.0% currently to 39.6% in 2013. Long-term capital gains, meanwhile, will be taxable at 20% for most investors and 10% for those in the 15% tax bracket or lower. A new Medicare surtax will also kick in that will levy a tax on high-income households' investment income, and the estate tax will ensnare many more estates if the exemption exclusion drops to $1 million, as it is scheduled to do next year.
What's a tax-savvy investor to do? First, what not to do: Congress could change its mind on a least some of these measures, so it's a mistake to act preemptively to reduce your tax bill until the new tax rates are a sure thing. Given the way Congress has been working lately (or rather, not working), there might not be clarity until late in 2012.
Nonetheless, getting familiar with these changes, and being prepared to adjust your portfolio strategies to limit the changes' impact on you, can help reduce your tax bill for 2013 and beyond. Here's an overview of what to keep on your radar.
Income Tax
Income tax rates are going up almost across the board in 2013, and the highest tax rate will jump from 35.0% currently to 39.6% in the 3.8% Medicare surtax on unearned income above certain levels (more on this below), and it's clear that certain high-income households could see a meaningful bump up in the taxes they owe beginning in 2013.
Strategies to Consider
Dividends
Qualified dividends, now taxable at a 15% tax rate for most investors and a 0% tax rate for those in the 10% and 15% tax brackets, will be taxable at ordinary income tax rates.
Strategies to Consider
Capital Gains
The increase in capital gains rates that's set to go into effect in 2013 isn't as drastic as the bump-up in the dividend tax. Capital gains rates for most investors are set to jump to 20% from 15% in 2013; those in the 15% tax bracket will pay tax at a 10% rate.
Strategies to Consider
Estate Taxes
Barring Congressional action, in 2013 the estate tax regime will go back to levels not seen in more than a decade, with a 55% tax rate on estates worth more than $1 million. That's quite a turnabout from where things stand for 2012, with the estate tax rate of 35% and estates of less than $5,120,000 exempt from estate taxes. Given that the $1 million amount would affect a broad swath of middle-class households (estates can encompass investment assets as well as residential real estate), it would be surprising if there were no Congressional action, but it's still worth keeping on your radar.
Strategies to Consider
Medicare Surtax
Beginning in 2013, a 3.8% Medicare surtax will go into effect for higher-income individuals (as well as estates and trusts) with net investment income above a certain threshold. Specifically, the surtax will be imposed on the lesser of an individual's net investment income for the year or modified adjusted gross income, or MAGI, of more than $250,000 for married taxpayers filing jointly. (The threshold is $200,000 for single filers.) If your modified adjusted gross income doesn't exceed those thresholds, you don't need to worry about the surtax.
Strategies to Consider
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