Tax rates are at near historic lows. These rates are the result of the Bush era tax cuts that were implemented in 2001 and are scheduled to expire Jan. 1, 2012. Barring some miraculous event before the end of this year, taxes are going up in 2013 on all households.


There is uncertainty in Washington about what to do. If Congress does not act, federal income taxes on short- and long-term capital gains are scheduled to increase, from 35 percent to 39.6 percent and from 15 percent to 20 percent, respectively. Taxes on dividends will go up as well. They are scheduled to increase from 15 percent in 2012 to 39.6 percent in 2013, and higher if you are filing in top tax brackets.

And now that the Supreme Court has ruled that the Affordable Care Act of 2010 is constitutional — on tax grounds, rather than the more expansive Commerce Clause — an additional Medicare tax of 3.8 percent will be imposed on what is considered “unearned income.” This effectively pushes the capital gains rate even higher.

Unearned income for this tax is investment income which includes interest, dividends, capital gains, annuity distributions (taxable distributions only and only when not from a qualified retirement plan), royalties, and passive real estate rental income. Taxable distributions from master limited partnerships and real estate investment trusts are not named in the tax code but probably will count as unearned income.

Distributions and pass-through income from partnerships and S corporations are more elusive. Most likely, the final rule will be that if income is subject to the self-employment tax it probably is not unearned income for this tax. But if you are a passive owner (one who is not active in the business) the income probably will be subject to the tax.

Unearned income for the tax does not include tax-free interest or distributions from qualified retirement plans, such as 401(k)s, traditional IRAs, Roth IRAs, profit-sharing plans, and defined benefit plans. Social Security benefits and life insurance payouts also are not subject to the tax.


There are some tax-planning moves you can make now to avoid or minimize the adverse effects of these changes. Planning for these presumed tax changes is a major undertaking. You should start beginning the process now to allow yourself additional time to implement tax savings strategies as well.

It might make sense for you to harvest capital gains in 2012 to take advantage of the current lower rates. You would sell appreciated capital assets and immediately reinvest in the same or similar assets. You would then hold the new assets until you would otherwise have sold them, so there would be no change in your investment strategy.

Deciding whether to use the strategy is not as simple as it might appear because the lower tax rates generally must be weighed against a loss of tax deferral. By harvesting the capital gains in 2012, you would be paying a lower tax rate, but recognizing the gains earlier. The greater the differential in tax rates and the shorter the time before the second sale, the more favorable capital gain harvesting would be.

If you have losing long-term securities positions, you may also want to sell those holdings before the end of the year. You can use the losses to offset gains on the profits you take this year, plus you can carry any excess losses forward and apply them against gains you may have in 2013. Given the higher rates in 2013, your 2012 excess capital loss carry forward will have an increased tax value.

The prospect of a top long-term capital gains rate of 18.8% to 23.8% next year (15% to 20% plus the 3.8% surtax) is good reason to wrap up planned sales of large assets such as companies or property before year-end.

Some believe the best strategy is to sell only those assets you were already planning to sell—but do it before the end of the year. Remember taxpayers who are not in the top bracket will see less of an increase if the Bush tax cuts expire than those in the top tier, particularly with regard to how dividends are taxed.

Investors need to be cautious in selling large amounts of stock. For some, a high volume of selling could have unintended consequences. Profits gained by selling stock could inadvertently put you into an alternative-minimum-tax (AMT) situation. The AMT will disallow many other deductions, which could negate any tax savings achieved through selling.

Higher taxes may not be the only risk investors should be worried about right now. Some fear that unethical advisors will see the uncertain environment as an opportunity to take advantage of unsuspecting investors. Beware of insurance brokers, stockbrokers, advisors, and others pressuring you to sell investments and use the proceeds to buy high-commission products that promise protection against taxes.

With all the uncertainty and varying scenarios on the financial horizon a consultation with a tax expert should be on your “must do” list. Due to the current uncertainty many investors will be selling off securities starting December 2012. Because of this increased sell-off at year-end, to avoid a decline in the profits from your stock sales, it would be advisable to review possible sales before the end of November 2012.

By performing due diligence and a little planning in 2012, you might be able to substantially reduce your overall tax burden in coming years.

Richard Simms Founder

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