My, What Big Teeth You Have! Minimizing This Year’s Tax Bite

Come April, some Americans will be shocked by their income tax bills, as new rates introduced by the American Taxpayer Relief Act (ATRA) of 2012 begin to bite. We estimate that the federal tax bill could rise 14% in 2013 versus 2012 for a hypothetical couple with the income summarized in the display below.

Sizing Up the Bite: Federal Tax Differences--2013 vs. 2012 ATRA introduced a new top marginal rate of 39.6% for ordinary income. Combined with the 3.8% Medicare surtax imposed by the Affordable Care Act of 2010, this results in a top federal rate of 43.4% for some types of investment income—taxable interest, non-qualified dividends, and short-term capital gains. At the same time, the top federal rate for long-term capital gains and qualified dividends went from 15% to 23.8%.

Many investors who noted these rates when ATRA first passed have since had their attention diverted by other issues. Fortunately, those who focus on their taxes now still have time to act. Tax-management strategies can be helpful under all circumstances, but when taxpayers will be subject to higher rates, the value of such strategies becomes that much greater.

You can defer income-tax payments by:

  • Increasing your contributions to retirement vehicles such as 401(k), IRA, and Keogh plans
  • Delaying the recognition of income (say, by deferring the closing of a large sales transaction); 
  • Harvesting portfolio losses to offset capital gains (This might seem to avoid a tax, but because loss-harvesting lowers the overall cost-basis of your portfolio, it increases the size of a capital gain that you will realize at some future time.)
You can avoid income taxes by:
  • Donating money or—better yet—appreciated assets to charity
  • Contributing to a 529 plan
  • Timing trades so that gains will be long term and dividends will be qualified
  • Holding appreciated assets until death (The resulting step-up in tax basis will relieve your beneficiaries of tax on capital gains that occurred during your lifetime.)
  • If your horizon is long enough, converting a traditional IRA to a Roth IRA (You’ll pay taxes now to avoid paying more taxes later).
If you establish a charitable remainder trust, you can both avoid a tax (by taking a charitable deduction for your contribution) and defer a tax (capital-gains tax on the sale of your contributed assets.)

The combination of strategies that will make the most sense for you will be highly dependent on your individual circumstances. The most important thing you can do now is determine the right strategies and put them to work before the end of the year, so that you can minimize the tax bill due on April 15, 2014.

The views expressed herein do not constitute, and should not be considered to be, legal or tax advice. The tax rules are complicated, and their impact on a particular individual may differ depending on the individual’s specific circumstances. Please consult with your legal or tax advisor regarding your specific situation.

Tara Thompson Popernik, CFA, CFP®

Director of Research—Wealth Planning and Analysis Group
Tara Thompson Popernik was named the Director of Research for the Wealth Planning and Analysis Group in 2011 and is responsible for leading research initiatives on investment planning and asset allocation issues facing high-net-worth families, family offices, and endowments and foundations. Previously, she was a wealth management specialist, and before that she was a senior investment planning analyst. Prior to joining the firm in 2003, Popernik was a paralegal in the Capital Markets Group of Cadwalader, Wickersham & Taft. She earned a BA with honors in comparative literature from Dartmouth College. Popernik is a Chartered Financial Analyst charterholder and a CERTIFIED FINANCIAL PLANNER™ professional.

Paul Robertson

Senior Portfolio Manager
Paul Robertson is a Senior Portfolio Manager and a member of Bernstein’s Private Client Investment Policy Group. He joined the firm in 1998 as a research associate and became a research analyst in 2000. In 2004 Robertson was appointed Senior Portfolio Manager and joined the Private Client Investment Policy Group. Between 2007 and 2009 he was also a member of the Alternative Investments team. Previously, he worked as a consultant for McKinsey & Co., Inc.; as a portfolio manager and quantitative analyst for Commonwealth Funds Management, an Australian funds manager; and as an economist for the Australian government. Robertson earned a bachelor’s degree in economics from the University of Melbourne, a law degree from the Australian National University and an MBA from Cornell University.

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