Money Matters: New tax laws require planning

By John H. Hamling
The Daily Record Newswire

Even though it is only the beginning of September, big tax hikes are coming in 2011 and again in 2013. Now is the time to start looking at what’s in your control.

As Bill Fleming explains in a recent article, “The new tax strategy demands multi-year planning,” published in the August 2010 edition of onWallStreet, the time to start thinking about taxes for the next several years and begin some strategic planning is now.

Be forewarned: This will be the exact opposite of traditional tax planning, because this year you may want to consider accelerating income and delaying deductions. A look at the highest tax brackets explains why.

Tax rates on regular income will increase to 39.6 percent next year, from 35 percent this year. Since income will be taxed at higher rates next year, deductions will save more next year as well.

There is a second tax bracket hike in 2013, when an additional 3.8 percent Medicare tax will be levied on investment income, and another 0.9 percent Medicare tax will be levied on earned income. At the same time, capital gains rates will increase to 20 percent in 2011, followed by an additional 3.8 percent in 2013. That equates to a 23.8 percent rate within the next three years.

Readers may want to consider some strategies to minimize the effects of the new tax legislation:

Accelerating income
High income taxpayers should consider accelerating as much income into 2010 as possible to help offset the health care bill’s 2013 Medicare payroll tax increase — set to rise from 1.45 percent to 2.35 percent for single taxpayers earning more than $200,000 and couples earning more that $250,000.

Business owners have more flexibility in accelerating income. While salaried employees have less opportunity, there is the possibility of using stock options. By exercising options in 2010 rather than during 2011 and beyond, income might be taxed at a 5 percent lower rate.

The most critical issue with stock options, of course, is the share price. A stock price increase after 2010 easily could erase any additional income taxes associated with the option exercise. Let’s say an employee has an option on 1,000 shares with an option price of $20 and the current price is $35. After 35 percent income taxes, he or she would net $13,000 if the option is exercised in 2010. If the employee waits until 2011, and the price rises to $38 per share, taxes will be paid at 39.6 percent but the employee will net $13,892. In that scenario, the employee should determine whether the stock price has the potential for increasing after 2010.

Delaying deductions
Deductions go further when tax rates are higher. It may make sense to delay deductions into 2011 and beyond. The only danger with the strategy is that a 2009 proposal from the Obama administration was to cap the tax benefits of deductions at 28 percent. To date, the proposal has gone nowhere.

Delay expenses
Start thinking about what expenses can be delayed until 2011. Business owners might want to consider what supplier payments can be delayed later this year, or partial payments made. The strategy is especially important for cash method taxpayers, who need to plan well ahead when it comes to expenses.

Consider putting the checkbook away in November and December. Don’t pay real estate taxes that can be delayed until 2011. Delay charitable contributions until 2011 when possible.
Other changes

• According to the Tax Policy Center, Congress’s failure to index the alternative minimum tax may lead to an explosion of AMT taxpaying families — from 4 million in 2009 to 28.5 million. Those families will have to calculate their tax burdens twice, and pay taxes at the higher level.

• Charitable contributions from IRAs no longer will be allowed. A retired person with an IRA currently can contribute up to $100,000 per year directly to a charity from an IRA. The contribution also counts toward an annual required minimum distribution. The option will not be available after 2010.

• Beginning next year, there will be a multi-billion dollar tax assessment imposed on name-brand drug manufacturers. Like all excise taxes, this will raise the price of medicine.

I’ve shared here just a sampling of the many new tax changes that will become effective in 2011 and beyond. Examine what variables are within your control when it comes to income and deductions.

Perform a multi-year analysis to determine tax brackets in 2010 and 2011. Set up a plan now with an appropriate schedule. You will be glad you did.

John N. Hamling is a vice president of Karpus Investment Management in New York. He can be reached at (585) 586-4680;