Tax Tsunami around the Corner, How to Minimize the Damage

2011 could be a very interesting year for taxes. My crystal ball has been broken for some time now, but it doesn’t take a fortune teller to see an increase in taxes for the future. Some increases are already known, like the 3.8% rate health care “surtax” that begins in 2013. 2011 remains a mystery, but if nothing happens, rates are going up.

Action by inaction

If congress does nothing between now and December 31st, 2010, the Bush tax cuts of 2001 and 2003 expire and rates will revert to the 2001 levels. The top rate moves to 39.6% from 35% in 2010 and the lowest bracket of 10% is removed. Capital gains and dividend tax rates are increased. Capital gains will move to the 20% bracket from 15% bracket in 2010. Dividend income moves to your ordinary income tax bracket. The child tax credit moves down from $1,000 in 2010 to $500 per eligible child in 2011.

Estate Tax

If congress does not act, the estate tax exemption amount is reduced to $1,000,000 in 2011 from $3,500,000 in 2009 (2010 has no estate tax). The top estate tax rate goes from 45% in 2009 to 55% in 2011.

What can you do?

The main thing to look at is taking income now rather than latter. Here are some suggestions:

• If you can collect a bonus this year instead of next year, do it.

• If you turn 70.5 this year, you have until next April 15th to take a distribution from your IRA, consider taking it this year instead.

• Consider converting a traditional IRA to a Roth IRA in 2010. This will help reduce your overall income in future years and may help you avoid the 3.8% “surtax”

     o Using outside funds to pay the conversion taxes can further help reduce income and the possibility of hitting the surtax threshold

• Consider shifting the income portion of your portfolio to municipal bonds.

     o Analyze the best after tax yield

• Charitable remainder trusts will be more appealing

• Ensure your estate is set up to properly maximize the use of the credit amount

Who knows maybe congress will act before next year, but if they don’t you can expect everyone to pay more taxes. Even the lowest earners would be affected. Some may see the total taxes paid double. People who rely on investments for income would also see a substantial increase in taxes. Remember dividend income is going from 15% to as high as 39.6%. Let’s hope that congress will act in time to prevent these increases from becoming reality, but if they don’t, be prepared.