Why You Might Want to Pay More Taxes
Your smartest tax planning move in 2012 might just be the one that sounds the dumbest. You and your adviser should figure out how to pay more taxes.
Ahem. As I brush the hurled rotten tomatoes off my suit jacket, let me explain what I did NOT just say. I did not just agree with President Obama that the affluent have a moral obligation to pay more in taxes. Nor did I agree with Warren Buffett that the very successful should want to pay more taxes.
Instead, my point is this: Taxes may be going up in the very near future, whether you like it or not. Just look at the deficit, the gridlock in Congress, and the fact that the Bush tax cuts are set to expire this year. Top it all off with the 2013 budget that President Obama submitted today. If you agree that higher taxes are coming, it could make sense to pay more in tax year 2012, so that you pay less later.
Given the tax outlook, these three strategies are worth considering:
1) Take some gains now If we get into next year without an agreement to extend the Bush-era tax law, the IRS will go from taxing long-term capital gains at the very favorable special rate of 15% to taxing them as heavily as it taxes ordinary income. If that happens, capital gain rates may increase by an astounding 113% for a top earner. If you sell anything this year to cash in on the 15% rate, you can immediately repurchase it to reset the capital gains clock with a higher cost basis.
2) Convert to a Roth For now, anyone is free to convert a traditional IRA into a Roth IRA. If you choose to convert, you pay tax on the amount converted in the tax year in which you do the transaction, rather than waiting until you withdraw the money to live off. So the decision really comes down to whether you want to pay taxes on your IRA now or later.
Taxes may go up next year and could keep going up up–so that they're much higher by the time you're retired and ready to tap your IRA. All that makes 2012 an opportune time for a conversion. If Congress keeps tax rates low next year as well, just undo the conversion ("recharacterize" it, in tax-speak), and your IRA will go back to being a traditional IRA. The law lets you hit the equivalent of the “undo” button for a 2012 conversion up until October 15, 2013. You'll know what 2013 tax rates will be by then. If tax rates go up, you can sit happily knowing that you paid a lower tax rate.
3) Delay a deduction You can choose when to take certain deductions. You can, for example, choose to pay your state's 4th quarter estimated taxes this year or next. You can bunch charitable donations in this year or double up for next year, and postpone (or advance) certain medical expenses. If taxes look like they might be going up next year, it could make sense to push some deductions into 2013; they could be more valuable to you then than this year. While that will cause you to owe more taxes in 2012, your combined tax bill over the next two years would be reduced.
No one wants to pay higher taxes (except Warren Buffett), but face it: You may very well have no choice, starting soon. Considering the direction that tax rates appear to be headed, you might calculate whether it's possible to pay Uncle a little now and save a lot later. 2012 might just be the year to do what Warren and President suggest, and give the government more money.
Chad Carlson, CPF contributed to this article
MARK BALASA | Columnist | Co-CEO, Balasa Dinverno Foltz
Mark Balasa, CPA, CFP is Co-Chief Executive Officer and Chief Investment Officer of Balasa Dinverno Foltz LLC. Mark has been named seven times as one of the ?Best Financial Advisors? in the U.S. by Robb Report Worth magazine.