Never before has the old expression about the certainty of death and taxes felt more accurate than it does right about now.
Several taxes are set to increase in 2011, including rates for income taxes, capital gains taxes and dividend taxes. The estate tax will also be revived next year. As part of the recent health care reform legislation, high-income earners will see an increase in Medicare taxes on both their wages and investment income in 2013. Other new taxes also are being discussed with more frequency, such as a European-style value-added tax.
Most Americans will feel the added weight of these increases. Those categorized as high-income earners will be required to carry the heaviest brunt. Still, there are some proactive steps individuals can take to help mitigate the impact of these many tax increases.
1. Re-evaluate investment income
Federal tax rate reductions for long-term capital gains and dividends are scheduled to expire this year.
The tax rate on capital gains from the sale of assets held longer than one year remains zero for people in the 15 percent tax bracket in 2010. The 15 percent maximum tax rate on long-term capital gains for taxpayers in higher brackets also remains the same. In 2011, those rates will rise to 10 percent and 20 percent respectively. Thus, if you have capital gains pending, 2010 would be a good time to take those gains. You can do this without re-allocating your portfolio.
Also starting in 2011, dividend income (other than capital gain distributions from mutual funds) will be taxed as ordinary income at your highest marginal tax rate (up from 15 percent for certain qualified dividends). Where possible, move such investments into tax-deferred pension accounts.
Finally, if you typically do not maximize annual pension contributions, you may want to defer some of your contributions into 2011.
2. Rethink timing of deductions
Thinking about large charitable contributions? While tax incentives are not the primary driver for most people, it is a relevant factor. You may want to consider deferring some of your contributions into 2011.
Do you anticipate a large business expense in the next couple of years? The Section 179 deduction for such expenses drops to $25,000 in 2011 (down from $135,000 in 2010, and after a drop from $250,000 in 2009). Here is a situation where you may consider accelerating business expenses, rather than deferring, to take advantage of the deduction before it disappears. However, this would require a careful analysis of your specific situation before making this decision.
3. Get professional advice for tax planning
Effective planning to minimize your tax risk takes time, effort and know-how. But with the coming deluge of increasing taxes, growing penalties and dwindling deductions, the extra work could be critical to your financial future. Working with a certified financial planner and certified public account can reduce your personal time commitment, while helping to ensure you make the most of any available opportunities.