Monday, October 18, 2010

Straightening out your taxes in 2011

Whether you like it or not, it's coming. The expiry of the Bush-era tax cuts means that a whole new era of budgetary responsibility is going to be enacted in 2011. If congress allows this to lapse (and it is no certainty that it won't), tax rates will once again be rolled back to Y2K levels. It represents a complete overhaul of things, but that will happen next year and will shift the burden of taxation towards high earners as opposed to the current system. So, if you want to know how to straighten your tax affairs in 2011 but want the short version, read only this one line; under the (proposed) new regulations, you are unlikely to be affected if your income falls below $200,000 as an individual or $250,000 for a married couple. If that's all you needed to know, there you have it, you need read no further.

If you do fall under that new tax bracket though, you will pay an extra 0.9% by way of taxes in 20133 and any investment income and gains will be subject to a 3.8% levy. Here's what's slated and how you can strategically maneuver to get the most out of an unfriendly 2011 tax code.

High incomes for high tax earners

This is very likely to pass and tax rates of 33 and 35 returning for big earners. If you fall under that tax bracket, try and take advantage of the 2010 rates by not deferring income into the next year. In addition, converting the usual IRA to a Roth isn't the best idea; instead, spread your tax bill over a period stretching to 2012. A Roth conversion is a tricky issue, so talk to your tax adviser about it.

Higher taxes on investment gains

This is as good as a done after the furore and anger towards investors skimming the market for profits. That said, don't sell winning stocks just to pay less taxes in 2011. If your aim is to re-balance your portfolio, by all means do so. But make sure it happens in 2010. That means taxes on long-term and short-term gains will be not as severe and the same argument holds true for home equity. Get it in while it won't be taxed as much.

The estate tax is back

The federal estate tax is zero as it stands right now, but taxes are being rolled back and this will likely be reinstated, with a tax rate of 55 % proposed on estates valued at $1 million to $10 million and 60 percent on estates worth more than that. The fact that the status of this proposal is up in the air doesn't help matters, but an interesting provision of the proposal caps the amount of tax payable for inherited property. This is is referred to as a stepped-up tax basis, and what it means is if you inherit property, you have to pay taxes based on what the cost was at the time of acquisition, not current market costs. That could be very handy indeed.

Almost no write-offs for high-income earners

The status of this is again unclear, and Barack Obama is strongly advocating the removal of personal exemptions and is a supporter of a proposition that would cap the deduction rate at 28%, but expect charities to be strongly opposed to a reduction in that deduction rate. Make a big gift to your favorite charity while you can, for that may soon change.

Changes to the Alternative Minimum Tax

This is not a big surprise since it changes every year in any case and it will affect the middle-class more than anything since the tax is not geared to factor in inflation. This one is coming for sure, and singles and couples will have to crunch the numbers and pay whatever the maximum taxable amount is. This affects parents particularly hard in states with considerable income and property taxes, such as New York or California. Other than simply moving, pray for tax reforms to come by after the next mid-term elections. Pay attention to this one, it might just hit you hard.
Desc: The expiry of the Bush-era tax cuts means that a whole new era of budgetary responsibility is going to be enacted in 2011.

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