The More Things Change, the More They Stay the Same ... For Now

February 15, 2011

By Lisa Brown, CFP®, CIMA®  Charlie Jordan, CFP® 

In December, Congress approved and President Obama signed into law a temporary extension of the “Bush Tax Cuts.” Included in this legislation is relief for payroll, income, estate and alternative minimum taxes. As part of the compromise between the President and the GOP leadership, the majority of provisions are scheduled to sunset at the end of 2012, a presidential election year. Even though we may find ourselves with uncertainty again in 2012, at least for now we can make better decisions knowing income taxes will not be a bigger drain from our pockets over the next twenty four months. A few of the key tax provisions include:

• Income tax rates are staying the same
• Payroll taxes decline in 2011 (the maximum tax benefit is about $2,100)
• The Alternative Minimum Tax is patched, excluding another $27,450 from this tax structure (which will benefit many high income tax-payers)
• Estate and gift tax limits rise to $5 million per person, with a top estate tax rate of 35%

For a number of tax-payers, last year represented a year of opportunity as taxes were feared to be rising sharply in 2011. For most, decisions made in light of the looming storm were prudent and timely. For others the opportunity appears to have simply been extended for a few years. As you work with your financial, tax and legal advisors this year, here are a few planning strategies to consider.

First, if you have not properly diversified your investment portfolio because of the tax cost involved and still have large unrealized capital gain exposure, consider a two year strategy to unwind concentrated positions. As capital gain tax rates are not increasing for the next two years, timing the trades should be based primarily upon investment considerations and not just on the tax impact. Work with your financial and tax advisors to determine the most efficient diversification strategy to ensure your portfolio is properly aligned to meet your goals.

The key to long-term financial success is to spend less than you make and invest the difference wisely over a number of years. Although many taxpayers may not realize just how much less disposable income they would have had if Congress did not act, lower income and payroll taxes means you will be able to keep more of what you earn. Even a modest increase in savings to retirement plans, education accounts, or even building up your cash reserves can result in greater peace of mind and financial security.

Thirdly, if you converted part or all of your IRA to a Roth in 2010, assuming your general income and tax situation is not expected to change over the next few years, it’s likely that reporting the conversion income over 2011 and 2012 will not cost you more in tax than reporting the income on your 2010 return. The ability for all taxpayers to convert to Roth IRAs did not end last year — this is a provision that is currently extended indefinitely, and a conversation that could remain on your tax planning agenda for a few more years.

Finally, the estate and gift tax provisions present tremendous opportunity for wealthy families to develop or refine plans for transferring wealth in a tax-efficient manner to the next generation. The estate tax was set to return in 2011 to a $1 million per person exclusion and a 55% top tax rate. (The gift tax was to remain at $1 million of lifetime exclusion.) The new law brings the estate tax back, but at a higher $5 million per person exclusion for both estate and gift taxes. This is a 500% increase in the amount of assets that can be passed to the next generation free of estate and gift taxes, with proper planning. This higher gift exemption creates a great opportunity for individuals with large estates who want to transfer assets during life to their family. And, for the first time, spouses can transfer their unused estate exemption to their surviving spouse which can lead to even greater estate tax savings for the family. As the estate and gifting provisions will expire at the end of 2012 without Congressional action, implementing wealth transfer strategies over the next two years could be impactful for many generations.

Tax law extensions, sunsets, and compromise — the more things change, the more they stay the same. Take advantage of this window to ensure you have a well-managed, globally diversified portfolio, a plan for passing your wealth along to family, friends and charity, and a team of trusted advisors to help you navigate through future uncertainty and changes that are sure to come our way.